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diff --git a/75730-0.txt b/75730-0.txt new file mode 100644 index 0000000..4745b23 --- /dev/null +++ b/75730-0.txt @@ -0,0 +1,5713 @@ + +*** START OF THE PROJECT GUTENBERG EBOOK 75730 *** + + + + + +Transcriber’s Note: Italics are enclosed in _underscores_. Additional +notes will be found near the end of this ebook. + + + + +THE WAR AND OUR FINANCIAL FABRIC + + + + + THE WAR AND OUR + FINANCIAL FABRIC + + + BY + WALTER WILLIAM WALL, F.J.I. + + FELLOW OF THE ROYAL STATISTICAL SOCIETY + AUTHOR OF “BRITISH RAILWAY FINANCE,” ETC. + + + LONDON + CHAPMAN & HALL, LTD. + 1915 + + + + +PREFACE + + +In this work I attempt to gather up some of the lessons to be learnt +from the experiences of the greatest of financial crises. Many +predictions have been unrealized and many theories destroyed, and we +are able, I think, to see with greater clearness and to grasp with +more boldness the problems that perplexed us in the past. Banking, +credit and currency problems have ever been subjects of contentious +controversy, experts and academic critics alike being unable to agree +upon their reading of phenomena and upon right interpretations. The +problems are indisputably complex, the most complex, probably, in the +vast domain of economics, and vision and logic have not guided us with +sureness amidst their intricacies. Hence we have groped and gone our +different ways, finding ourselves at no common goal. Royal Commissions +have been asked for in order to tackle and, if possible, to find +solutions that will be universally acceptable. For some time before +last year’s crisis a small committee of bankers had been sitting in +order primarily to deal with the reserve problem and the provision of +emergency currency. It is believed they were on the point of presenting +a scheme to deal with future crises when the sudden outbreak of the +war put an end to their labours. Whether or not their scheme will +ever be made known to the public may depend upon future developments. +Perhaps the public may never be enlightened, for it may now be thought +that inspiration and genius discovered the most practical solutions at +the right moments. Something had to be done swiftly. And that which +was decided upon swiftly revealed deeper insight, maybe, than slower +deliberation. + +This is not uncommon, however, in the career of genius. Civilization +has profited more, perhaps, from flashes of inspiration than from +uninspired controversy. + +In order to build up my arguments I start from the foundation, and in +the earlier chapters deal with the monetary problem and the general +working of the banking system. These lead us into the region of +dialectics and controversy and to a survey of the happenings during the +crisis. + +I urge amongst other contentions that banks do not in the true +connotation of the word create credit. If it be possible to convince +ourselves that they do not create credit, that credit is a something +existing prior to and independently of banking, it will, I think, make +the gold reserve problem easier to solve. What we gaze upon is not an +unsubstantial structure called in Lombard Street “the superstructure of +credit,” but is something more solid. It is a superstructure of wealth. +All that banks do is to transform this wealth into liquid capital, +resolve it into its constituent, or original, elements. This enables +wealth to perform its fructifying functions, to reproduce itself, just +as the mature fruit reproduces itself when re-sown. Were the wealth +to remain in its fixed, or, as the market would say, its frozen form, +what sort of wealth-harvest could we hope to gather from it? Unless it +be made liquid it cannot flow. And if it did not flow, but remained +frozen, sterility would result. If this transforming machinery were not +provided by banks, the Government, on the nation’s behalf, would have +to provide it, or the nation would become inert. As there is not, and +never can be, enough legal tender coinage for this work, other legal +tender currency should be provided. + +In answer to those who have ever clamoured for high gold reserves I +have endeavoured to show the impossibility, in the present system, of +this realization. What critics have at the back of their consciousness +is, not quantity _per se_, but proportion. They do not mean a mere +counting of sovereigns, but the ratio of an individual bank’s reserve +to its liabilities. A small bank cannot have as much gold as a large +bank, but it can have as high a proportion. Now, a high proportion +can be attained only by keeping down the loan-deposits. It cannot be +attained by getting a larger quantity of gold if the loan-deposits +grow correspondingly. When banks see these deposits rising and the +proportion falling, they cease lending, call in their loans, and allow +the proportion to rise. We then see what we fallaciously call the +loan-fund of Lombard Street diminish, showing that the loan-fund is not +in the deposits, but in the gold reserves and in the totality of the +wealth in the keeping of the banks at any given moment. + +When banks cease to lend they drive borrowers to the Bank of England. +Borrowing there causes a drop in the Bank’s proportion. Therefore, +we cannot have simultaneously high proportions of joint stock bank +reserves and a high proportion of a Bank of England reserve unless +both stop lending simultaneously. As the Bank’s reserve is the reserve +of the joint stock banks collectively and the national reserve, then, +if its proportion falls, the reserve-proportion of the entire system +falls. The only way to keep it high is for all to stop lending and for +the whole money market to lapse into a state of stagnation. So far as +my knowledge extends, this has not been pointed out. + +We know that efforts are made, by raising the Bank rate, to replenish +the reserve automatically from outside sources. But whether the gold +flows in or not, it does not disprove the fact that a high proportion +in the independent joint stock banks and in the independent Bank +of England cannot be maintained at simultaneous moments except by +a simultaneous refusal to lend. It needs no exceptional power of +imagination to picture what would result from this action. It would +have the same consequences as a great destruction of capital by war +or any other calamity. If we had an elastic legal tender system, to +provide for what I call a supplementary inflow of legal tender, we +could avoid many inconveniences from which the money market and the +nation suffers. + +The supply of liquid capital in a perfect economic system should keep +pace with the output of wealth. But our system is not perfect. Progress +must necessarily be impeded by artificial and arbitrary restrictions. + +I think, too, we could simplify the problem by segregating the +composite deposits of a bank. These deposits are an aggregation of +what I call, for lack of something more precise, pure deposits and +loan-deposits. The loan-deposits are debts to the bank, which the +bank has power to call in. If these loan-depositors have legal power +to withdraw money on demand, the banks have power to withdraw from +many of them on demand. On the approach of a crisis, or stringency, +they do this, though in certain contingencies such withdrawals might +precipitate a crisis. Nevertheless, the important fact remains that +they have power to call them in. + +If we set the gold reserves against the pure deposits we shall find +that the reserve is invariably high. + +But why do we want a high proportion? Why do we wish to hoard gold, +when we know that the hoarding of gold is more harmful than beneficial? +To avoid a panic, the critics and seers say. But a panic is not a +mathematical problem; it is a psychological problem. If mathematics +could save us from fear and madness we could then automatically ensure +general sanity and common sense. What mathematical proportion will save +us from a panic? Who is to lay down the proportion? Where are we to +draw the magical line of safety? Is it to be an exact proportion or an +approximate proportion? Is it to be an universally exact or universally +approximate proportion? Or is it to be an individually exact or +approximate proportion? There can be no exactitude, particularly if +we include the Bank of England. In mathematics, however, we must have +exactitude, for half per cent below the formula might be fatal. And if +in order to keep up the proportion simultaneously in Lombard Street and +Threadneedle Street lending ceases, then the crisis comes, despite the +proportion. + +A psychological disease is not to be diagnosed by the mathematician. +We must find a psychological remedy for it, and that remedy is +knowledge and common sense. The nation that met the crisis in August +last so calmly and has faced since, resolutely and philosophically, +the most terrible ordeal of its existence, is not likely to be seized +with ungovernable madness because we cannot get an exact mathematical +formula in dealing with bank reserves. The knowledge, and the only +knowledge that will keep them sane and calm, is that banking is +conducted soundly. The confidence of the community is based, and justly +based, upon sound banking methods. So long as banks transform into +currency the best wealth, then they are soundly managed, irrespective +of mathematical gold reserves. The best wealth is to be tested by +time--that is, by its durability. The highest wealth is durable; the +lowest wealth transient. + +If we are to have no solid, lasting confidence in sound banking, only +in mathematical ratios, and if the highest wealth the banks possess are +to stand them in no stead in a panic, then banks can reasonably refuse +to liquefy the best wealth. We could not in that case blame them if +they speculated. If they maintain the mathematical inexact ratio laid +down by critics they will be mathematically safe, for sound wealth in a +panic will, the theorists say, be as worthless as unsound wealth. + +If banks are conducted soundly, if they perform vital services to +the nation, if the nation would stagnate without those services, if +the nation restricts their freedom of action by the provision of an +inadequate supply of legal tender and by the law of legal tender, then +it is the duty of the nation to help them in that trouble for which +they are not responsible. It is also expedient for the nation to do +this. It would be conforming to the law of self-preservation. To do +otherwise would be national suicide. + +Banks cannot do two contrary things at the self-same moment. They +cannot keep a high proportion and in the same moment lend freely. If +they lend freely the proportion speedily falls, and might speedily +fall far below the mathematical formula of safety. If they do not lend +freely the mathematicians say they will aggravate the crisis. The only +sensible course for the nation to take is to be its own physician. The +Government on its behalf can do again what it did last year--provide +a supplementary fund of legal tender currency. This was effective +more than half a century ago, and it has been effective again. And +experience is of greater value than theory. + +These, then, are some of the questions I discuss in the following +pages. I do not expect, of course, to find common agreement. This would +be presumption. Nothing is more difficult than to destroy theories. +Experience is often impotent. Prophets are not always silenced when +their predictions are unrealized. They continue to prophecy. They +predicted confidently that when the world-war came the financial crisis +would be far worse than the military crisis, and that this country +would be in the throes of a panic the dimensions of which no human +imagination could conceive. Foreign countries with vast credits here +would take away every sovereign and every bar of gold they could lay +their hands on. Only those sovereigns would remain that we had been +far-sighted enough to store in our back gardens, or, if we had no back +gardens, in our discarded stockings. Nothing of this happened. There +was no financial panic, no raid upon our gold reserves. If there was +any apprehension it was mild and momentary, thanks to the soundness +of our banking system, the strength of our financial structure, and +the wisdom of our Government, to say nothing of the soul of the +nation. It was discovered that, instead of other countries having it +in their power to take gold from us, they were so greatly in our debt +that they could not liquidate those debts, and the exchanges went +violently against them. Since then gold has flowed into the country +in unprecedented amount, and there is still no sign of interruption +to the flow. This country is now overwhelmed with gold. The reserves +of the Bank of England and of the joint stock banks continued to grow +so rapidly that loans, or “credits” as they are called, glutted the +market. Banks lent with difficulty even on nominal terms. So far from +predictions being fulfilled, that has come to pass never dreamt of in +the wildest of dreams--a land towards which, in the midst of war, the +golden river was flowing, fed by tributary streams, and undiminished +in volume by huge purchases of warlike stores and material from neutral +countries. + +The country was saved by wisdom--by the wisdom of the people and by the +wisdom of the Government which promptly acted on the wisest advice. +This begot confidence and strengthened faith. It was calm confidence +and serene faith in intellectual ability that enabled the country to go +through the crisis with success and that evoked the profound gratitude +of all. + +Confidence, the energizing, vitalizing spirit of economic progress is +distinct from what is called Lombard Street credit. Yet both connote +a confiding in or a believing in something. In what? Confidence is +fundamentally a confiding in the greatness of the nation. There can be +no confidence in the littleness of a nation. + +The financial writer would probably be discharged who wrote in +his money article: “Confidence in Lombard Street yesterday was in +superabundant supply, and sellers could find no borrowers of it even +on nominal terms. In fact, before the close of business balances of +confidence were unplaceable. Overnight confidence fetched no more +than 1 per cent. and weekly confidences 1½ per cent. In consequence, +therefore, of this great mass and weight of confidence the discount +market was very weak and rates fell further. It is thought probable +that the Bank of England may have to make confidence scarcer and +dearer by taking it off the market, that is to say, by borrowing +confidence.” + +Is, therefore, that superstructure of “credit” that superstructure of +confidence beneath which the country economically prospers? Is there +not often in Lombard Street an abundance of “credit” coincident with a +scarcity of confidence? And is not all this “credit” impotent without +confidence? Is prostrate confidence to obtain its re-creative power +only from mountainous gold reserves? Or will it be regenerated by a new +faith in the essential greatness and wealth of the country? + +I have great hopes of the future. I give abundant reasons for this +faith within me. Experience has taught me the incalculable harm +pessimism does. Pessimism is like an infectious disease. It spreads +quickly. It is difficult to fight against it. There are numerous +sad-visaged prophets amongst us to-day--men without hope, men without +a smile. They cannot cheer us. They see coming, with the inevitability +and irresistibility of doom, the day of sorrow, the day when we shall +reap the abundant aftermath of woe. But dark as the night may be, I +see a new day of joy dawning, a day when the sowers will go forth with +renewed hope and energy, with the confidence that they will gather in +at the due season a harvest more abundant than they have reaped before. +Let us not wring our hands and moan in dark corners. Let us look +forward with brave hearts and strong minds to the day of victory and +peace. That day will bring us a new faith, a new confidence, perhaps a +new happiness in which we shall forget the old griefs and despairs. + + W. W. W. + + CATFORD, S.E. + _February, 1915._ + + + + +CONTENTS + + + CHAP. PAGE + I. INTRODUCTORY 1 + + II. WHAT IS MARKET MONEY? 13 + + III. THE CURRENCY OF CUSTOM 23 + + IV. CREDIT AND CONFIDENCE 32 + + V. SOUND BANKING 43 + + VI. THE SUPERSTRUCTURE OF WEALTH 51 + + VII. WHAT IS THE LOANABLE FUND? 61 + + VIII. THE METAMORPHOSIS OF THE FUND 70 + + IX. THE CENTRAL FUND 80 + + X. THE CENTRAL RESERVE 88 + + XI. THE FIDUCIARY CURRENCY 97 + + XII. BANKING WEALTH 107 + + XIII. ELASTICITY OR INELASTICITY? 117 + + XIV. EXHAUSTIBILITY 128 + + XV. THE THEORETIC LINE OF SAFETY 139 + + XVI. SOME PSYCHOLOGICAL PHENOMENA 149 + + XVII. EQUITABLE RESPONSIBILITY 156 + + XVIII. CORRELATION 166 + + XIX. THE SUPPLEMENTARY INFLOW 172 + + XX. CREDIT AND CIVILIZATION 184 + + XXI. CONFIDENCE AND GREATNESS 193 + + XXII. FROZEN WEALTH 202 + + XXIII. SOME CONCLUSIONS 211 + + APPENDICES 221 + + + + +THE WAR AND OUR FINANCIAL FABRIC + + + + +CHAPTER I + +INTRODUCTORY + + +Treatises innumerable have been written about money. Famous and +non-famous political economists have attempted a definition of money. +These definitions have been divergent, and often irreconcilable. +Political economists have found it no easier to arrive at a simple, +understandable, explicit formula than literary critics have found it to +define poetry. All of us have a vague idea of what money is, but it is +so vague that it is well-nigh impossible to present it in a concise and +precise phrase. + +This amazes the man in the street, who believes that nothing is so +simple, nothing so easily conceivable as money. To him, of course, +money consists of so many pounds, shillings, and pence, and when that +is said, all is said. What more is there to explain and define? He is +wealthy or poor, comfortable or miserable, according to the quantity +of pounds, shillings, and pence he possesses. He knows that he can +satisfy his needs, his desires, his cravings if he has enough money +with which to buy what he wants, but if he has insufficient his needs +and longings will not be gratified. + +He knows that when he goes into a shop he exchanges money for +commodities. When he purchases a pair of boots he does not tender for +them a watch, or loaves, or a couple of tender chickens that he has +bred on his poultry farm. He hands over a few shillings, receives the +boots neatly packed, thanks the shopman, says “Good-day,” and is quite +unconscious that he really has exchanged for the boots commodities that +he or some other members of the community have produced. + +It would be waste of time and labour, in a treatise of this character, +to devote several chapters to the evolution of money, or, rather, +to the evolution of those articles that have served the usages of +exchange. Those who desire to acquaint themselves with these historical +facts must consult the many works devoted thereto. The world’s monetary +systems, at the stage now reached by them--it does not follow that it +is a final stage--are the outcome of experiments and improvements in +national and international exchange. In primitive days direct barter +was resorted to. Goods were exchanged directly for goods, commodities +for commodities. The baker took his bread to the tailor when he was in +need of a garment, and the maker of footwear took his handiwork to the +baker or the butcher when he wanted food. + +This worked well enough in small communities living in circumscribed +areas, having no intercourse with communities living at inaccessible +distances. But as the communities grew, as their boundaries expanded, +as they came into closer touch with other communities, as distance +became shortened by the discoveries of means of transport, as +individual and collective mentality strengthened, these primitive +communities had to face the increasing inconveniences of direct barter. +Necessity stimulated ingenuity and invention until in the course of +ages the inconveniences were lessened by the use of selected articles +for exchange. These were selected partly because of their scarcity and +partly because of their durability, for it was discovered that scarce +things were prized more highly than things that were abundant. + +That which was scarce, therefore, by being more highly prized became +what we call more valuable. That is to say, more store was set by its +possession. The possession of it excited admiration and envy and greed; +admiration and envy are the bases of economic value to this day. They +are not the bases of ethical value, but economic law and moral law are +opposed in many directions. + +Scarce things, therefore, were just as much prized by primitive +people as they are prized by civilized people to-day. It was these +scarce things, therefore, that could be exchanged for an abundance of +things, because no one valued what could easily be got and what all +could have. There was a time when iron was scarce. As iron, too, was +most useful for a great variety of purposes and as its utility was +constantly showing itself, its scarcity, added to its usefulness, made +it increasingly prized and valued. A ring of iron for a crown was of +greater worth once than are the diamond-studded crowns of present day +monarchs, and iron was at one time scarcer than diamonds and rubies +are now, and a man in possession of a little iron could exchange that +possession for a great quantity of cattle with the man who had more +cattle than he knew what to do with. Cattle, therefore, were what we +call cheap and iron was dear, the primitive idea being, as it still is, +that cheapness consists in much and dearness in little, irrespective of +their values in preserving life. + +Iron was dear because it was scarce, cattle were cheap because they +were plentiful. But man cannot live by iron, though he can live on +cattle. Judged, therefore, from the standpoint of life-preservation, +cattle should be more precious than iron; but judged from the +standpoint of envy and vanity, iron was, as gold now is, of greater +value than cattle. The one preserves life, the other pride, and here we +see some components of the foundation on which the economic fabric has +been reared. + +A savage with a little iron and no live stock was considered wealthier +and more enviable than the man with no iron and a vast quantity of +live stock. The man in possession of the iron knew that he could get +as much live stock as he wanted by parting with all or only a portion +of his iron, and when he exchanged a portion of his iron for cattle he +actually parted with money. The iron and the cattle were money--the +iron was the sovereign and the cattle the pence in those days. + +Now, the iron being scarce and being highly valued by the community +on whose land it was found, a greater value was conferred upon it in +time by law. The king and his counsellors of those days enacted that +a certain quantity of iron should discharge so much taxes or redeem +so much debt, that the Government would accept it in payment of taxes +and in liquidation of debt, thereby absolving the payer from all +legal responsibilities and penalties. From being merely an instrument +of custom iron was raised to the higher function of being a legal +instrument. It was given a certain arbitrary value, the value being +expressed in the amount of taxes it should represent and in the amount +of debt it should legally discharge. + +Great importance lies in the conception that the legal, apart from the +custom value, was purely arbitrary. + +Cattle would be accepted in payment of taxes and in discharge of debt +also; but, being more plentiful, and therefore of less value, the +Government decreed that so many cattle would be equivalent to so many +pounds of iron. Those who had no iron, therefore, had to pay in cattle, +just as in these times those who have no gold must pay in silver or +bronze. + +Although a diamond may be worth many sovereigns, it will not be +accepted by the tax collector, nor by our creditors, because it has no +legal value. That is to say, it is not a legal instrument. + +We are beginning to have some glimmering now of what money is. Money +performs two important functions. It is a medium of exchange and it is +a standard of value. + +Money was the instrument man invented, after mental travail, to lessen +or remove the inconveniences of direct barter. + +Money represents the possession of a claim on the products of the +community. It is a present and a future claim upon a portion of the +wealth of the general community. When the claim is exercised it +performs its function of a medium of exchange. + +The idea is this. We are all potential consumers and producers. We +have read of the early Christian community, when all the members of +that community brought their goods and possessions to the common store +and divided equally. This is precisely how society lives to-day. We +all bring our goods and possessions to the common store, or market, +as it is called, and there they are divided. But they are not divided +equally. This is the chief difference. They are divided unequally in +accord with our notions of equitable distribution. + +Our claims on the common wealth are supposed to be based justly upon +our individual produce. The more we produce the more we claim, the +less we produce the less we claim. This is the fundamental idea, or +hypothesis; but, like many ideas or hypotheses, the practical working +of it is far from just and perfect. But the fundamental idea will make +clear the function money performs. + +We are familiar with those schemes of relief in times of distress +when tickets are given to the poor, representing a certain quantity +of food. On presentation to the butcher the ticket is exchanged for a +pound of meat, and on presentation to the baker it is exchanged for a +quartern loaf. These tickets are money. They are a media of exchange +and possess exchange value. They are claims on the butcher or baker. +If the possessor chooses, he can exchange the ticket with another for +a pint of ale, and the other can claim the meat or the bread. They can +pass from hand to hand, become currency, as money is called, and the +exchange can be effected immediately or deferred. + +The meat and the bread are subsequently paid for out of another fund, +and the butcher and baker hand over the tickets and are paid their +respective portions out of this common fund. + +Now, the Government of the land can proclaim, if it pleases, that these +tickets can represent permanent claims on the community. Instead of +being destroyed, they can be used over and over again for an indefinite +period--be made what is called legal currency. + +What the laws have done is to decree that gold, silver, copper, and +paper shall represent our claims on a certain proportion of the +nation’s wealth. When we take our products to market we exchange them +for these claims. These claims we afterwards present to the butcher, +baker, and tailor, and when we have got rid of them we have exhausted +our claims on them. If we can get no further claims we become poor or +destitute. The only means of getting fresh claims is to bring more +wealth to market and exchange it for more claims, and according to the +quantity and quality of that wealth, so are the claims we get greater +or smaller. The greater our claims the richer we are, the smaller +our claims the poorer we are. If we bring to market products that no +one wants and people will not exchange part of their claims for our +merchandise, then we know our labour has been in vain. + +In order to live, we must obtain these legal claims on the general +wealth, and if we cannot obtain them we starve or become parasites. + +A distinction exists, and a most important distinction, between money +and legal tender currency. Anything may be money. If I have no legal +tender currency and only a gold watch and I am in great need of a dress +suit and I offer the watch for the suit and the watch is taken, that +watch is money. It is no one else’s concern if the tailor accepts the +watch in exchange for his labour, his skill, and his cloth. He has +liberty to exchange the dress suit, if he pleases, for some ancient +ornament he desires to possess, instead of for legal coin or currency. +But he knows that the ornament will satisfy only his desire, and will +be no claim on any portion of the community’s wealth. The butcher will +not accept it for meat. But it has performed the function of money +nevertheless. + +The law has decreed, however, that there shall be a species of money, +or currency, that shall have permanent value as a medium of exchange. +It has decreed that all must accept this in exchange for wealth and in +discharge of all legal obligations. With this object in view it has +chosen gold to be the legal claim, and has set up gold to be what is +called a standard of value. Treatises have been written on standards +and on values. Both are highly controversial subjects, but these +controversies must be ignored here. + +This standard, or unit of value, is called in Great Britain a +sovereign. It was decreed that this coin should consist of an +arbitrary quantity of gold, mixed with alloy, and that it should be +stamped with certain designs. These designs alone make it legal money, +or legal tender. If I had a coin, containing exactly as much gold as +a sovereign, and worth exactly as much, but plain, with no design, it +would not be a legal coin. It would not be accepted in discharge of +debt, in payment of taxes, in exchange for wealth. I could, perhaps, +sell it to the jeweller for something below its real value, because he +could make use of the metal to advantage; but it would be useless to +buy meat and bread with. + +The law, therefore, has decreed that a coin composed of gold, of a +certain weight, and with certain designs upon it shall be a legal unit +of value, and that so much silver and so much bronze shall be equal +in value to this unit. It has decreed that sovereigns shall be legal +tender for liabilities to an illimitable amount, that silver shall be +legal tender to the maximum equality of £2, and bronze to the maximum +equality of one shilling. That is to say, a creditor, if he chooses, +can demand gold in redemption of his debt beyond £2, but whether he +will put the demand into execution or not depends upon his will or +circumstances. + +It is necessary, therefore, to lay emphasis upon this distinction +between money and legal tender currency. Money is relative wealth, +because it represents relative, temporary claims; but legal tender +currency is absolute wealth because it represents absolute, permanent +claims. + +If Germany conquered this country and enacted that the sovereign should +no longer be legal currency, and that the mark should be substituted +for it, the sovereign would then become a commodity, worth only its +value in gold. Sovereigns are commodities abroad, just as continental +gold units are commodities here. Sovereigns have no legal value on +the Continent. Francs, marks, and dollars have no legal value in +this country. What, in each country, confers upon the commodity gold +its legal function as money is legislative enactment. Legislative +enactment can also make a comparatively worthless product like paper +of much greater value than gold. The paper value of a note for £100 is +trifling. But because the Government has decreed it shall be worth one +hundred sovereigns, then the individual members of the community take +it at its face value. What is its value in Germany, especially when we +are at war with Germany? + +This shows the great and arbitrary power the Government of a nation +possesses. + +It can make stones legal tender if it chooses. Or it can make diamonds +legal tender. Many nations have made silver and not gold legal tender. + +When individuals of a nation exchange commodities they exchange it as +in national legal tender. There is, however, no international legal +tender. When nations exchange commodities the payment is made in +different instruments, such as bills of exchange. Whenever gold is +exchanged it is exchanged solely as a monetary commodity, and not in +its national legal character as money. The gold in the sovereign is +valued according to its quantity, and not by its value as a legal +instrument, token or claim. But it is rarely that gold passes from +one country to another in payment for goods received. This payment is +managed in a much easier and less expensive fashion. + + + + +CHAPTER II + +WHAT IS MARKET MONEY? + + +What is the money that is bought and sold in the money market? Who are +the merchants there? Who are the middlemen? Who are the sellers and +buyers? What sort of a place is this money market? We can visualize a +cattle market, where farmers bring their cattle to sell, and we can +visualize Covent Garden, where fruit, vegetables, and flowers are sold: +but can we visualize a money market? Is it in some vast building in +the City? Is Lombard Street a mighty emporium where many merchants +congregate at their stalls and offer, in the same fashion as vendors of +apples and sweets do, pounds, shillings, and pence for sale? + +It is not located in any spacious building, like the London Stock +Exchange. Buyers do not go there and offer golden sovereigns for +golden sovereigns and silver shillings for silver shillings. To the +ordinary man, who is perplexed by the mysteries of the money market, +it sounds strange, indeed, that money can be bought with money. This +is because he associates money with pounds, shillings, and pence, +and cannot understand a sovereign being bought with a sovereign. +Yet he understands the business of a money-lender and he understands +borrowing. He knows that when he borrows from a money-lender he +borrows money and pays something for the loan, something that he calls +interest. Well, the vendors of money in Lombard Street are purely and +simply money-lenders on a great scale. + +Banks are wholesale business houses where money is made, and where +money is sold. The selling is not, however, on all fours with apple +selling. When we sell apples we part with the apples for good. We do +not lend them for a definite period to the buyer, and the buyer does +not return them at the end of that period. In buying and selling apples +an absolute exchange is made, money and fruit being definitely parted +with. + +In the money market the merchandise of the merchants is not exchanged +in this absolute fashion, so that, in the literal connotation of the +word, Lombard Street is not a market. + +Lombard Street is an organism, essential to the vitality, health, and +welfare of the body politic, as the heart and the lungs are necessary +to the complete life-preservation of the human body. The nation could, +of course, live without Lombard Street. But without it, it would be a +corpse-like, moribund life in comparison with the vitality and energy +imparted to it by this economic organism. + +In Lombard Street money is made. What kind of money? Some strongly +insist that no money is made, but only what is called credit. This, +too, is a highly controversial subject, on which divergent views are +held and are likely to be held. + +Instead of hoarding our money, placing our golden sovereigns in bags +and old tea-pots, and burying them in our cellars, we have reached that +stage in our economic development when we place them in the keeping of +banks. We have several purposes in view in doing this. We place money +in the keeping of the banks for absolute safety; we place it there +for convenience; and we place it there to earn what we call interest +on it. Hoarding, we are intelligent enough to know, would be unsafe, +inconvenient, and unprofitable. + +Yet we really obey the instinct of hoarding when we place our savings +and surplus money in the keeping of banks. But we have a secondary +motive in this action which we will call greed or avarice. We desire +our hoards to be fruitful. It is like placing seed in the ground from +which to gather future harvests. + +But the banks do not hoard our money. If we think they do we labour +under a delusion. They employ it in various ways. They lend it to +a variety of borrowers at interest, they invest it in all kinds of +securities and property, and earn interest on it by this varied +employment. Out of this interest they maintain their vast and +expensive establishments, pay the salaries to their servants, and pay +the interest on the money we, as individuals, place in their keeping. + +The position might be illustrated in a simple way. I have saved up two +hundred pounds. These two hundred sovereigns I place on deposit at the +bank, and am allowed, say, 2½ per cent. interest. I prefer the small +interest because I believe the principal will be safe always, safer +than if invested in any security or property. Moreover, I know that I +can draw this money out whenever I please, but were it locked up in +some security or mortgage, I should not feel sure of getting possession +of it again in a moment of need. But the bank, lawfully, must return me +intact the two hundred sovereigns when I ask for it. + +Now the bank re-lends this £200 at, say, 4 per cent. interest, making +a profit of 1½ per cent. interest. Out of this interest it must pay +salaries, rent, and all working expenses. How can it do it? + +It doesn’t do it, and it couldn’t do it. No such miracle could be done. +This £200 is multiplied greatly. The bank can make that £200 into £1000 +or £2000, and actually lend £2000. If I went one day to ask for the +£200, the bank might tell me it could let me have only £10 or £20, and +if I insisted on having the £200, it might have to close its doors and +go into the bankruptcy court. + +How is this £200 made into a fund of £2000? Do the sovereigns actually +multiply in the bank’s coffers? Is there a bank fairy that can +make sovereigns out of nothing? No. There is no bank fairy, and no +sovereigns are multiplied. Yet the bank says it has £2000 to lend, and +lends £2000. + +That which it lends over and above the original sum of £200 is said +to be the bank’s credit. The bank is said, in the terminology of the +money market, to create credit to this extent. It keeps, say, ten or +twenty sovereigns in its till to provide for the emergencies of a +sudden demand, and lends the rest of the gold and something beyond it. +This something else is called credit. Some people say it is to all +intents and purposes actually money; others declare it is not. And in +discussions on this subject a lot of anger has been wasted and more +vanity wounded. + +Anyway, whether we call it money or whether we call it credit, the fact +is indisputable that this is the tangible or intangible something with +which banks benefit the trade and commerce of the nation, and help us +all to become wealthier. This is the so-called money of Lombard Street. + +They risk, however, grave dangers, and the community risks grave +dangers in setting up this machinery to facilitate and smooth national +and international commercial dealings. These dangers will be unfolded +gradually in subsequent chapters. + +Already it has been hinted where one danger lies. + +If of that £200 I place £100 on deposit and £100 on current account +at the bank, the bank has still a total of 200 sovereigns, and can +multiply this sum into £1000 or £2000. But it pays interest then only +on half the sum--the sum on deposit. On the other half it pays no +interest, but it can lend the whole. If I desire to withdraw the £200, +I can by law draw half on demand. The bank, however, can insist on some +days’ notice before allowing me to withdraw the amount on deposit. But +if I insisted on having £100 and the bank had only £20 and could not +get the other £80 quickly, it might have to close its doors. This would +be a run on the bank that might bring it to ruin. + +The bank hopes, of course, that I shall not demand my money in a lump +sum at a moment’s notice; that there will be no run. It also hopes that +if I do demand it, it will at once demand the return of its loan, or +part of its loan, from those who have borrowed from it, and thereby get +the two hundred sovereigns it owes to me. It will then be in a position +of having still on loan money, or credit, based apparently on no gold. + +If it is not based on gold, it is based, however, on some kind of +wealth. Those who have borrowed from the bank leave securities, +Consols, say, as collateral for the loan. If they do not repay the +loan, the bank has the securities, which it can sell in the market for +cash. + +If it has no gold, it has something it can exchange for gold. + +It now becomes a little clearer that what the bank has actually done +is not to create £1800 out of nothing, but to liquefy £1800 of the +nation’s wealth. Is this process of liquefaction granting credit or +creating currency? It looks more like a creation of currency than a +creation of credit. If the bank lent without security, then it could +with greater logic and reason be called a creation of credit. But it +does not so lend. + +If gold is wealth and Consols are wealth, then it lends wealth, whether +it lends gold or Consols. Therefore, what the banks apparently do is +to lend one man’s wealth to another man, taking a commission from the +borrower for the services rendered. If Consols were made legal tender, +like sovereigns, we should not say that lending Consols was creating +credit. + +Selling Consols in the market is not creating credit. The selling of +Consols to a banker for a consideration is not different essentially +from selling them in the market. The borrower virtually sells them to +the banker, and so long as the banker holds them he is not creating +credit. + +If a man hands over to me his mansion for a loan, that mansion is mine +till he repays the loan. He has sold it to me temporarily. By lending +him the money I possess I do not lend him credit. I may part with all +my money, but I have the mansion, which I can sell for money. If I +cannot sell it, I may lose much. But that will depend upon my wisdom +and foresight. I, at least, have something of some value in the shape +of the mansion. + +It is so with banks. Their security depends upon the nature of the +wealth they liquefy. If it be the best wealth their security is sounder +than if it be the worst wealth. It is not necessary, and it should +certainly never be necessary, in the real interests of the community, +to liquefy only one kind of wealth. + +Banking security should rest, therefore, chiefly upon the highest +wealth of the nation and not solely, as some contend, upon that limited +species called legal tender. This aspect of the problem will be +elaborated in later chapters. + +Let us take another look at our modest current account. We draw cheques +against this current account. We pay our income tax, our rent, our +tradesmen, with these cheques. The cheques are accepted readily and +unquestionably by all. Why? Because the cheques, the paper, have +intrinsic value? No. But because they have trust in our _best_ banks +and trust in our possession of the money in these banks. A cheque on +the _worst_ banks would not be so readily accepted. + +But we all know that the sovereigns are not actually there. Does the +drawing of a cheque create credit? Or is the drawing of a cheque merely +the evidence that we actually have what we profess to have? In drawing +a cheque we do what the banks do when they grant a loan. When we pay +for a suit with a cheque we receive the suit in exchange. When a banker +draws a cheque and receives Consols or bills of discount, he really +buys the Consols and buys the bills. But some contend that he buys the +Consols with nothing. So it can be contended that we bought our suit +with nothing in the event of the bank smashing. + +The cheques we draw become currency, become, in the essential meaning +of the word, money. They are not legal tender; but legal tender is only +a small portion of the nation’s currency, that portion arbitrarily +selected by the legislature for a specific, but important purpose. + +That that selection is wise is a view not unanimously held by economic +thinkers. + +But it is a selection that must control the policy of bank management +to a paramount extent. This does not exclude, however, the scope and +expediency of legislative reform. + +We cannot draw cheques against our deposit accounts. But though we can +withdraw these deposits the bank can insist, as I have said, on certain +notice. This notice, however, is never insisted upon. It would be +injudicious to insist upon it. It would be injudicious because it would +give rise to the suspicion that the bank was unsoundly managed and in a +bad way. And suspicion is the surest way towards the destruction of a +bank. + + + + +CHAPTER III + +THE CURRENCY OF CUSTOM + + +A simple illustration has been given of how we entrust our money with +a bank and how a bank employs it. Let us in our next step analyse a +typical balance sheet of a big bank, for it will help us to get a +clearer notion of the functions of a bank and of the character and +complexity of the money market. + + _Dr._ + + £ _s._ _d._ £ _s._ _d._ + + TO CAPITAL AUTHORISED 30,000,000 0 0 + To Capital ISSUED 3,000,000 0 0 + To Reserve Fund 1,125,000 0 0 + To Amount due by the bank + on Current, Deposit, and + other Accounts 37,583,237 8 11 + To Acceptances on account of + customers 3,153,328 7 11 + To Rebate of Interest on Bills + discounted, not yet due, + carried to new account 53,807 1 3 + To Amount of Nett Profit 225,676 10 1 + --------------------- + £45,141,049 8 2 + ===================== + + _Cr._ + £ _s._ _d._ £ _s._ _d._ + + By Cash in Hand and at the + Bank of England 5,996,667 14 8 + + By Money at Call and Short + Notice 5,674,476 5 1 + ----------------- 11,671,143 19 9 + + By INVESTMENTS-- + + Consols and other Securities + of, or guaranteed + by, the British Government, + of which £35,000 + (Stock) is lodged with + public bodies 2,488,966 12 6 + + By Indian, Colonial Government + and other Securities 3,771,738 10 11 + ----------------- 6,260,705 3 5 + + By Bills Discounted 6,811,870 13 8 + + By Loans, Advances, other Accounts + and Securities 16,218,748 12 6 + + By Liabilities of Customers for + Acceptances as per contra 3,153,328 7 11 + + By Freehold and Leasehold + Premises 1,025,252 10 11 + ------------------- + £45,141,049 8 2 + =================== + +On the liability side the capital issued is the amount paid up by +shareholders, capital which the bank has employed in the ordinary +course of its business. It represents a contingent liability to these +shareholders, who have invested their capital for the sake of the +return in the shape of dividends. The large sum of thirty-seven and +a half millions is the most important item. This is the real working +capital of the bank. It is apparently the aggregate amount deposited by +the public with the bank. + +This is what the bank owes to its clientele. + +But the deposits are not solely money actually placed with the bank. +This huge sum includes the loans the bank has made to other customers, +to its borrowers. Every loan makes an additional deposit. The man who +borrows a sum of money from the bank is credited with that sum and the +credit appears in the current accounts. The bank has security for this +loan, and, as already pointed out, this security is liquefied into bank +currency. Cheques can at once be drawn against it so long as the loan +runs and cheques are the country’s currency. Securities, therefore, +have been converted into national currency and indirectly into legal +tender. + +The more, therefore, a bank lends the more do its deposit and current +accounts grow. + +The reserve fund speaks for itself. It is generally a fund accumulated +annually out of profits and invested in the best securities. The larger +the reserve in proportion to the capital and business the stronger is +the bank’s position. It is a provision against future contingencies and +is not touched except for these contingencies. One purpose is to meet +depreciation in investments or other losses. The money being invested +in the highest securities these can be sold for cash whenever the need +for it arises. + +The acceptances on behalf of customers are also practically covered +by securities deposited by customers, until they lodge the funds to +meet the bank’s liabilities in this direction. The net profit is the +fund due to the shareholders of the bank, who receive their dividends +therefrom. + +On the asset side, the cash in hand and at the Bank of England consists +of coin and notes. A portion of this is in the tills and safes of the +bank in order to meet the ordinary daily needs, the incomings and +outgoings, while the rest is money deposited with the Bank of England +in precisely the same way as an individual deposits money with a joint +stock bank. It serves two purposes. It composes an additional reserve +there in legal tender, and facilitates the clearings between the +various banks, debits and credits being daily adjusted in the books of +the Bank of England. + +It is contended by many that the banks do not keep reserves large +enough in proportion to their liabilities--reserves, that is to say, in +actual legal tender. It is contended that they trade on too slight a +margin of gold, or legal tender; but this question must be threshed out +when the way has been cleared for it. + +The next item is the money at call and short notice. This is +practically the money lent by the banks to money brokers, stock +brokers, and discount houses. Money at call practically means that +the bulk of it is lent from day to day and that banks can demand +its repayment at a moment’s notice. The money is also borrowed on +security, so that while the banks owe the money to the borrowers +and the borrowers owe the money to the banks, the banks have the +securities. These securities thereby become currency. They can also +become currency if the public will accept them as currency, but the +public prefers cheques to securities. The greater convenience of +cheques need not, of course, be emphasized. + +It will be seen that a bank’s “investments” are a large sum. They +include the reserve fund, and the bank’s annual income is, of course, +swollen by the interest it receives on these investments, in the same +way as an individual’s income is increased. These investments are of +the very highest class and strengthen the assets the bank possesses +against its liabilities on deposits. It is presumed, of course, that +they can be readily sold for cash should the need for the conversion +arise. + +Bills discounted reveal the character of another source of income. They +represent investments in another high-class security. A few bills may +be discounted directly on behalf of customers, but the bulk are bills +re-discounted from the discount houses. Bill brokers discount bills at +a certain price and the banks re-discount them at a lower price, and +both, therefore, make a good aggregate profit out of the business. Bill +brokers are practically the middlemen between merchants and the banks. + +These bills of discount being an investment and a sound security +are thereby liquefied into ordinary currency and ordinary capital, +capital which the merchant is able to use in the ordinary course of +his business, while the nation at large benefits from the increased +capital employed and the greater production and consumption that are +the immediate fruits of it. + +The largest item on the asset side is the composite one of “loans, +advances, other accounts and securities.” These include customers’ +overdrafts and advances to customers on all kinds of security and +estate, and may, perhaps, be regarded as the least liquid or the least +readily realizable assets a bank has. In this item are its chief risks, +and, perhaps, the soundness of banking is best judged by the size of +this account. The larger the size the greater, presumably, are the +risks; the smaller the size the less are the risks. + +But the aggregate forms a portion of the wealth of the community. A +customer gives some kind of security when he overdraws his account. But +all this composite wealth, of whatever class its component elements may +be, is, by the machinery of the bank, converted into currency. These +loans amount to nearly half the liabilities on deposit and current +accounts, therefore additional currency to this amount can be placed +in circulation. If no banks lent on such wealth there would be less +potential capital in circulation; the capital would be as stationary +and as unfruitful as hoarded coin. While, therefore, the bank owes this +sum to the borrowers, giving them power to draw cheques against it or +to take out the whole sum in cash, the borrowers owe the money to the +bank; for the loans interest has, of course, to be paid according to +the class of security lodged. This interest is one of the chief sources +of a bank’s income. + +The liabilities of customers for acceptances has been explained. They +offset the item on the liability side. They may be regarded as a +moderate source of a bank’s income, and this class of business has to +be done with great care. As for the bank’s premises, this is its own +property in which it must do its business, and it is self-explanatory. + +Having analysed a typical bank balance sheet, we are able to see the +kind of business a bank conducts and the valuable functions it performs +on behalf of the community. A bank is in reality a manufacturer of +currency--not of legal tender currency, but the currency of custom. +The Government does not provide this necessary machinery, so the banks +provide it, and we can imagine what would happen to the country if the +machinery broke down, or if it were compulsorily stopped. + +This custom currency has become so much an integral part of the +economic and financial structure of the country, that even our +tax-gatherers will accept a cheque as readily as sovereigns. Our +currency is to all intents and purposes a paper currency, the soundness +of which is rarely questioned. It is not legal tender currency, but it +is as vital to the well-being of the nation as legal tender currency. + +The other paper currency is Bank of England notes and, since the war, +Treasury £1 and 10_s._ notes. Even though the whole of these notes may +not be convertible into cash, they are legal tender simply and solely +because the legislature has enacted that they shall be legal tender. +This is, of course, something outside custom. If the legislature were +pleased to do so, it could enact that cheques on certain specified +banks should be legal tender, just as it arbitrarily enacted that the +new Treasury notes, issued without any gold backing at first, should be +legal tender, equal to the amount of their face value in gold. + +I wish to emphasize the distinction, therefore, between the currency of +custom--something that has grown up out of the needs of the community, +something essential to its welfare and progress, the product of an +advanced stage of economics and of civilization--and the currency +called legal tender. Though debts are paid and are payable in custom +currency, the power of this currency to redeem debt could be destroyed +in certain circumstances, the circumstances of a panic. They may be +remote circumstances, but, remote as they are, they raise deep problems +which to this day are discussed with energy and heat. + +Ought the Government to provide machinery more adequate than that it +does provide to meet the currency needs of the nation? This is one +aspect of the problem. Some say it ought to provide it, some say this +does not come within its province. It is left to the banks to provide +that currency as best they may and quite apart from their methods +of providing it, it is indisputable that they administer to a vital +economic need. If, therefore, they administer to that need, should the +Government come to their assistance in those circumstances which cause +a collapse of their machinery? + +This question has been answered in part by the Government since the +outbreak of the war. It helped the machinery to work, and provided +against a possible collapse by issuing “emergency” currency notes. +The Government having acknowledged an emergency and established a +precedent, the problem is now much simplified. + + + + +CHAPTER IV + +CREDIT AND CONFIDENCE + + +Credit, which banks are said to create, has several connotations. +It has a social, an ethical, and a financial connotation, and it is +necessary to examine awhile these connotations. From the derivation, or +original conception of the word, or idea, it is an expression of belief +or trust, as distinct from disbelief and distrust. + +In the social world, when we say a person stands in high credit, what +is it we imply? That he is a rich man, a man of great wealth? By no +means. He may be a poor man, that is to say poor relatively to the +position he occupies. In the social sphere he can carry considerable +weight even though he may be dishonest, dishonourable and immoral. We +ignore his vices, yet hold him in high esteem. His credit is based less +on his character than on our snobbery. We bow before title and caste, +irrespective of the merits of the individual. A lord of bad character +will be more sought after, receive more flattery and deference, than +a no-titled man of noble character. If we were not snobbish we should +despise him as he deserves. + +From this springs the desire of men to gain title, no matter what +means and methods they employ to this end. They know that a title in +some potent way aggrandizes them, and they can enter an assembly with +greater assurance and confidence and pomposity than they could if their +names were still as plain as in their humble days. + +The conferring of a title is not necessarily a recognition of high +moral worth. But a title can be a national recognition of intellectual +merits, or ability. The credit of those who receive this distinction +is strengthened. We have greater confidence than before in their +intellectual ability and power. We have deeper trust in their wisdom +and sagacity and in their counsel. We have the less hesitation in +following their guidance in those paths with which they are presumed +to be intimately familiar. In this greater, but still restricted, +knowledge of theirs we repose our trust. + +We know that moral credit is distinct from this. It is based upon +character solely, irrespective of social position or means. A poor +man may be a man of high nobility. We may despise his poverty, but we +honour his spirit. We are conscious that he is far beyond us, that we +cannot reach the moral plane upon which he stands. He is a man in whose +honesty, integrity, and conscientiousness we would place unquestioning +trust. We know that in no circumstances would he disabuse that trust. +We know that he would have the moral power to resist all temptation. + +Such a man may have great strength of character, high moral worth, +but he may be weak intellectually. He may be no scholar, no man of +erudition, no man of imagination, and possess no exceptional ability. +His intellectual limitations may be the cause of his poverty. But +in whatever position he may be placed, according to his limited +qualifications, we know that he will discharge his duties faithfully, +conscientiously, to the best of his ability, and will not swerve a +moment from the path of honesty and uprightness. Such a man could be no +thief and could tell no lie. + +He lessens our anxieties. We say we can trust him as readily and as +confidently as we can trust ourselves. It is a matter for thankfulness +that we have such a servant in whom we can place our trust. + +Here, therefore, are illustrations of intellectual and moral credit +which men are said to possess. + +Financial credit is another kind of credit. With this, perhaps, mankind +is more familiar. The economic standing and welfare, as distinct from +the purely moral standing, of a nation is dependent upon what we call +financial credit. If I lend money to a friend it is immaterial to me +what his abilities or his morals may be, so long as I know he will be +in a position to repay that loan. If his moral credit be bad, he will, +perhaps, not repay it if he has the means; but even if his moral +credit be bad he may pay it from motives of expediency. He may want a +further loan later, and it would not be to his material interests for +me to propagate the fact that he will not repay his debts. His credit +is worth too much to him to be placed in jeopardy of this kind. He must +redeem the debt if only from the business motive of expediency. + +Tradesmen are said to live on credit. They declare that if they refused +to grant credit to their customers they would speedily be in the +bankruptcy court. By granting such credit they run grave risks. They +have to trust to the honesty of their customers and to their future +means. Therefore they have to face the risks of incurring losses by bad +debts, phenomena inseparable from such business. On the other hand, +they believe that by granting such credit and running such risks they +extend their custom and compete with hopes of greater success against +their rivals. What they may lose in the way of bad debts they may more +than recoup in the larger profits they make on the growth of their +business. + +It may be, from an ethical standpoint, a degrading and deplorable way +of living on each other in a highly civilized community, but the fact +serves the purpose of illustrating our ideas of financial credit. + +We have to live by trusting in each other, trusting in each other’s +financial means and financial honesty. A man may be highly moral and +respectable in his life, a worthy husband, father and citizen, an able +and faithful servant, thoroughly trustworthy, yet may be mean and +financially dishonest. Or he may be the victim of misfortune and cannot +redeem his debts to the tradesman and others even if he would. + +Looking more closely into the credit on which a tradesman relies we +find it altogether different from the credit which, it is declared, +banks create and prosper on. We can, perhaps, contend that a tradesman +lends cheese, butter, and eggs, in the hope that he will be paid for +them eventually. + +I am the customer. I ask him to let me have cheese, butter, and eggs +for a month, and I will pay for them at the end of the month. Were I a +stranger to him he might demur. But if he has known me for years and +knows that I am a man of my word, a man to be trusted, he will gladly +let me have the goods on the credit of the reputation I hold with him. + +What is the tradesman’s security? Simply my word and my reputation. +Simply his trust in me. I do not leave with him my watch, my +securities, or my works on political economy. If, however, I failed to +pay for the goods I received of him and had left some of my valuable +possessions with him, he could sell these possessions in the market, +and indirectly be paid for his goods. + +If he were indirectly paid for them, would he be granting me credit? He +would certainly not be granting that kind of credit which the man in +the street understands as credit. Political economists and financiers +may be distinct from men in the street, but the simple-minded, the man +unversed in the theories of political economy, would see no difference +between this and barter. In fact, it looks exactly like the barter so +beautifully and so fascinatingly described in primers on political +economy. However, we do not pledge our watches with the grocer for eggs +and bacon. We pledge our words and our character only, and at the end +of the month we hand him over a cheque, the national currency, and once +more demonstrate to him the value of _our_ credit, not _his_. + +Perhaps it is now less difficult for the simple-minded to comprehend +why political economists, financiers, bank managers, and those highly +gifted men, financial journalists, cannot come to a common agreement +as to what it is banks create. There is more agreement amongst them +that banks do really lend than there is as to the actual thing banks do +lend, credit or money. + +Perhaps they do not lend at all, neither credit nor money? Perhaps they +no more lend than my employer lends when he pays me my weekly cheque +for services rendered. We call them lenders, because it would seem +absurd to call them converters. Yet it seems obvious that they do +quite a large business in conversion, akin to what the Bank of England +does when it converts gold into notes. The latter converts one species +of wealth into one species of currency; the joint stock banks convert +another species of wealth into another species of currency. + +My employer pays me a cheque for services rendered. I am presumed to +have produced some kind of wealth, which is converted into liquid and +current capital when I receive the cheque and put it in circulation. +When he gives me the cheque he does not give me credit. He pays me for +the wealth I have produced and which the community has consumed, and +that wealth goes to the common store. + +If a banker lends me, as it is said, £200 on Consols--to put it in +round, simple figures--does he sell me his credit, or do I sell him +mine? Or is it, after all, barter? If it be bartering wealth, then it +cannot be credit. If he lends me £200 and takes my Consols, he takes my +wealth from me. It is no longer in my possession. He has it, and if I +leave that £200 on deposit and do not withdraw a single sovereign, he +is wealthier to the extent of £200 than he was before. + +If he be so much wealthier, what has he exchanged with me? What has he +sold to me? If he lends me £200 on my credit, plus the Consols, and I +borrow £200 from him on his credit, less the Consols, then we seem to +exchange credit for credit. If credit be a species of wealth and credit +be exchanged for credit, then wealth is exchanged for wealth. + +But, I repeat, this is not the sort of credit the tradesman understands +and lives on, nor is it the man in the street’s conception of credit. + +Yet it is declared by those who pretend to a deep knowledge of human +psychology and temperament, that the stability of banks depends upon +the credit they enjoy amongst the members of the community, and that +that credit, in its turn, is dependent entirely on the proportion of +gold the banks hold to their deposit and current accounts. It is quite +possible that this is a delusion. Financiers may have misread the +public and may not be completely acquainted with their arithmetical +preoccupations. I do not believe that one man in 100,000 deliberately +and seriously sits down each evening and works out the proportion of +gold held by his particular bank in its last balance sheet. + +The ordinary individual believes that he can use his leisure moments +more profitably and more pleasantly than in this occupation. I do not +believe that one man in 500,000 could say off-hand approximately what +is the proportion of his own bank or the average proportion of all +banks. He doesn’t trouble to know, and he doesn’t bother himself about +it. He will tell you that he is burdened with quite enough anxieties +to trouble himself with this unnecessary anxiety. + +This is my experience of my fellow-men, and I shall not put greater +faith in financiers than in my own experience until they have +cross-examined every individual depositor in the country and given me +each one’s answer. + +If, therefore, it be a delusion that confidence resides in individual +knowledge of the exact proportion of gold banks hold to their +liabilities on deposit and current account, then what is the basis of +the national confidence? It is not an individual confidence, but a +general confidence. + +I believe that this confidence is based, and justly based, on the +belief that our banks are soundly managed. This belief is a tradition, +a habit, a custom. We inherit it as a nation, and the inheritance is +handed on from generation to generation. We can, indeed, say that it is +in our blood, in our system. + +Years have rolled on and this confidence has not been abused. There +have been times, of course, when the country has found itself face to +face with a financial crisis, but it has been saved from disaster by +the wisdom of men in high financial stations and by the common-sense of +the nation. And this confidence has been further strengthened by the +manner in which we have faced the greatest war in which the nation has +been involved. + +I shall analyse the phenomenon further in later chapters, but I will +say here that the manner in which the general public received, as a +mere matter of course, the creation of the emergency currency notes +revealed a psychological trait, or characteristic, of tremendous +importance. + +It is my belief, then--in fact, it is my conviction--that, so far as +the general public is concerned, its confidence in banks rests more in +the belief of their honest and sound management than in the knowledge +of the exact amount of gold they have in their reserves, or where they +actually hold their reserves. And I believe, too, that if all were +interrogated, forty-four millions and more out of forty-five millions, +including some of our shrewd bank managers, would say they believed +that that confidence would be strengthened if the public were assured +that all the reserves were held at the Bank of England than in the +safes of the joint stock banks. + +When the man in the street says that a something is “as safe as the +Bank of England,” it is no empty phrase. The safety of the Bank of +England is ultimate, absolute safety. He associates the safety of the +Bank of England with the safety of the nation itself. The Bank of +England could fall only when the Empire itself fell. And that fall, in +his conception, seems as remote as the fall of the skies. + +He would tell you, and tell you with all solemnity and earnestness, +that he would rather have his money at the Bank of England than +elsewhere. And if he were told that that is the very place where the +joint stock banks keep their gold reserves, he would say, with equal +seriousness: “That’s right.” His mind would then be at rest that all +was absolutely right in the best of all banking worlds. + + + + +CHAPTER V + +SOUND BANKING + + +If it is indisputable, therefore, that the confidence of the +individual, and therefore the confidence of the nation, is based in +the soundness of banking, we must see if that confidence be justified +or not. I have, indeed, already said that it is justified. I must give +reasons why I think so. + +What is banking? What is soundness of banking? These terms must be +defined. + +I do not know if a definition of banking has been given that is +universally acceptable. I know what the vague conception of banking is, +but if a precise, explicit definition has ever been given, agreed upon +unanimously by economic theorists, and accepted as the right and only +formula, I am ignorant of that fact. + +I consult Nuttall, and he describes a bank as an establishment which +trades in money, by receiving, lending, exchanging, etc. He does not +say it is an establishment which trades in credit, by receiving, +lending, and exchanging credit, etc. This definition may be false and +misleading, and Mr. Nuttall may have been deplorably ignorant of the +functions of a bank, but as, in my opinion, it is as good a definition +as I have met with in economic and financial works, I will accept it. +At any rate, I consider it in no wise false or misleading. + +A bank trades in money. This is indisputable. A bank receives money. +This is indisputable. A bank lends money. This is indisputable. A bank +exchanges money. This also is indisputable. + +What money does it trade in? We know there are various kinds of money. +Legal tender currency is but one kind of money. Cheques, bills of +exchange, securities, and even commodities are other kinds of money. +Even if the legislature declared that only legal tender shall be money, +the legislature could not by this declaration alter the laws of nature +and of economics. It can make one kind of money legal tender, but it +cannot destroy the law that anything used for exchange purposes is +money. If a beggar steals a watch and afterwards exchanges the watch +for a decent shirt, the watch and the shirt become money. They perform +the functions of money and the functions prove that they are money. + +A bank trades in money subscribed by its own shareholders and money +deposited with it by the public. A bank in the course of time finds +itself in the possession of what it describes as its deposit and +current accounts. These accounts, it is popularly supposed--included +in the populace are political economists and City financiers--are the +aggregate of the money placed with a bank by the public and the money +with which it mainly trades. + +These are called a bank’s liabilities, its immediate liabilities the +redemption of which can legally be demanded at a moment’s notice. It is +because they can be so demanded that banks are ever faced with a grave +potential peril. + +It is necessary to clear the way by destroying a delusion. This money +on deposit is not entirely money placed in the keeping of a bank in the +same fashion as one would keep money in a safe. This fact, in my view, +is of great importance. Only a portion of these deposits is what we may +call in an indefinite way pure deposits. By pure deposits I mean money +placed with a bank that is not a direct loan. If I place £100 of my +savings in a bank, instead of investing it, I call that a pure deposit, +and this money I can withdraw without the subtraction of a farthing at +a moment’s notice. + +But we have already seen, from our analysis of a bank’s balance +sheet in Chapter III, that these deposits are not all pure deposits. +A considerable portion of them consists of loans to all kinds of +people, loans made on the security of various kinds of wealth. That +is to say, the bank owes money to these so-called depositors and the +depositors owe that money to the bank. The depositors have the power, +of course, to withdraw the entire sum of money lent to them temporarily +by the bank; but the bank, in due course, has the power to claim the +redemption of the loans. Not only has it this power to call in these +loans, but it actually possesses the equivalent of the loans in a +portion of the country’s wealth. + +It is possible--but the wisdom or unwisdom of it need not be discussed +here--for the legislature to enact that only pure deposits should +be withdrawable at a moment’s notice, and that borrowers should be +compelled in times of panic or vital urgency to give long notice. I +merely say that this is within the power of the legislature to enact, +but I do not say here that it is practicable, necessary, or wise. + +I merely throw out the hint here in order to emphasize the importance +of the distinction between pure deposits and loan deposits. The latter, +I have already urged, may be regarded as the product of the machinery +for converting wealth into currency, or liquid capital. From a sound +banking standpoint the vital question to be considered and answered is +as to the kind of wealth that is so converted. + +Sound banking is to be tested by the nature of the wealth so converted, +or, in the language of the financial community, the wealth on which +loans are made. + +Others argue that this is a matter of quite secondary and even +third-rate importance. They contend that the matter of supreme and +vital importance is the amount of gold a bank holds in proportion to +its liabilities in deposits. Should there be some differentiation +here? Should it be the amount of gold held in proportion to its pure +deposits, and not in proportion to its aggregation of pure deposits +and loan deposits? For the loans, as we have seen, are automatically +redeemable. + +If, say, a bank habitually holds gold to the proportion of 15 per +cent. of its aggregate deposits, and if half these deposits are loans, +then the gold Will be equal to 30 per cent. of its pure deposits, a +proportion much higher than the figure advocated by those who agitate +seriously and zealously for higher gold reserves. + +We have seen many small banks go under in recent years. This was in +some cases because they lent their money on what I will call bad +wealth. In other words, because they gambled and speculated with the +money of their depositors. Here we have some evidence that the general +public are unable to discriminate between sound and unsound banking. +This may be deplorable ignorance, but it is not culpable ignorance. It +is to a great degree inevitable ignorance. + +The matter is dismissed by the quidnuncs saying that fools deserve +their misfortune, they should have placed their money in sound banks. +We should not so readily denounce them as fools. The Government is +not without its most serious responsibility in the matter. It should +not allow such money-lending establishments to describe themselves as +banks. The Government has a moral duty to protect the public, and it +would not be at all difficult to take steps to this end. It should +allow only those establishments to call themselves banks that are +conducted upon sound banking principles. + +Joint stock banks have a legal safeguard. Though they are under +compulsion to repay deposits, they are under no legal compulsion to +repay them in gold. They must repay them in legal tender, and they can +fulfil their legal obligations by paying out in legal tender notes. +These, of course, are Bank of England notes and now the new Treasury +emergency notes. + +This being so it is immaterial, or it should be immaterial, whether +the reserve of a bank consists of gold or legal tender notes. If it +can redeem its liabilities in notes and has sufficient notes for its +purpose, it can consider itself safe and can securely stand in a +crisis. The notes can, of course, be taken to the Bank of England and +be exchanged there for gold; but this is immaterial to a bank which has +successfully met the peril of a run. + +Soundness of banking consists in the soundness of the wealth that +constitutes a bank’s assets. We know there are infinite degrees and +categories of wealth. But it is easily possible to discriminate and +know exactly which is the highest class of wealth in the country. + +Banks do and must speculate to some extent. It is unavoidable. If they +did not speculate they would not incur bad and doubtful debts. But +they must keep their speculations within the most prudent limits. This +most of them undoubtedly do. Traders complain that they are, indeed, +too cautious in this respect, that they do not lend freely enough. +There have been, indeed, most bitter complaints on this head since the +outbreak of the war. + +But we cannot reasonably insist upon banks being ultra-cautious, and in +the same breath complain of their cautiousness. We cannot reasonably +insist upon them keeping large gold reserves, thereby diminishing their +loan capacity, and with equal reason insist that they shall lend with +increased liberality. + +This is as impossible as trying to reach two goals simultaneously, when +each lies in a direction opposite to the other. The man in the street +would say you cannot eat your cake and have it. + +When a bank lends to a man or firm on good security, it cannot be sure, +of course, that that man or firm will be able to pay off the loan when +it falls due. + +We may, if we wish, call this a speculative chance, but the bank is +considerably safeguarded by the security it possesses. + +Public confidence is based, therefore, upon the soundness of banking +methods. It is an article of belief with us that banks become gravely +imperilled when confidence breaks down. It is when confidence is +destroyed that runs on banks commence. Fear seizes the public, it +develops into panic, depositors clamour for their deposit money, and +banks either successfully meet these runs, or close their doors. But so +long as confidence is strong and unimpaired, sound banks keep safe. + +The safety of banks depends, therefore, upon this feeling of confidence +in them, and this feeling of confidence, in its turn, is based upon +the intelligence and common sense of the public. Up to now this +intelligence and common sense have been triumphant. They have triumphed +in a crisis unparalleled in the history of the British Empire, in that +very crisis, in fact, which the prophets always feared would show their +superficiality and vulnerability. + +The predictions of the prophets have not been realized. This is because +human genius and human wisdom have been mightier than human fear and +apprehension, because the nation had supreme faith in the Government, +in the economic strength of the Empire, and in the might of its navy +and army. + +And if the prophets have prophesied falsely in this supreme situation, +they are just as likely to prophesy falsely in other potential +emergencies. + + + + +CHAPTER VI + +THE SUPERSTRUCTURE OF WEALTH + + +In our loose and indefinite way--as a result, maybe, of our defective +vision--we talk of a vast superstructure of credit erected on a tiny +gold basis. We gaze upon this mighty fabric and shake our heads +ominously. As we gaze we see the structure grow, extending upwards and +outwards, enlarging itself by some invisible and mysterious agency, and +when we cast our gaze to the foundations we see that it looks like a +towering edifice perched insecurely on a small, uneven piece of rock. +No wonder we have feared that when storms break the whole crazy thing +will come crashing down, scattering ruin and devastation in a vast +area around it. It seems to us like a structure built by a madman, in +defiance of the laws of architecture, and that there can be but one +end, sooner or later, to so fantastic a fabric. + +So have we been told time and again that our superstructure of credit +has been built only for fair weather and not for foul. + +Well, it has withstood much foul weather since the building of it +commenced generations ago. Storms have beaten against it, and to the +naked eye it has hardly swerved. The storms have made no rents in its +walls, and it still stands, growing visibly, pointing its rising apex +to the skies, and millions of people to this day--stolid, unimaginative +Britishers, maybe--enter within its portals fearlessly and without +suspicion of their peril. They heed not those who warn them that the +whole thing may fall about their heads at any moment, that it needs but +an earthquake, and all will be over in the twinkling of an eye. + +“Foolish people!” these architectural guardians of safety cry. “We have +warned you, and you have heeded us not. Let your fate be upon your own +heads. Let him who is guided by the feeble, confusing light of his own +folly, suffer the doom of his folly. We, at least, have done our duty, +bravely, like voices crying unto the lost multitude, drunk with its +ignorance and conceit.” + +Well! well! Perhaps, after all, this superstructure may have no +counterpart in reality. It may be but a fantastic dream, or nightmare, +after all, yet seemingly so vivid to our fearsomeness that we find +it almost impossible to believe that it can be but a creation of the +imagination. + +Would it not be more accurate to say that we have erected in our +midst a vast superstructure of wealth? And cannot we say that this +superstructure is based, not upon a slight foundation of gold, but +upon the solid wealth of the nation, the empire, the world? If it can +be proved to our nervous eyes that this is the real superstructure, +after all, and not the one we have seen in disturbing visions, perhaps +we shall feel more secure against and less apprehensive of the force of +storms. + +Let us look more closely at that balance sheet, for then we shall come +into actual physical contact with the composition of this awe-striking +structure. We will analyse the various ingredients which we shall +describe as the assets of a bank. + +First of all, we see that the cash in hand and at the Bank of England +is nearly £6,000,000. This is legal tender, that which the law of the +land has enacted shall be absolute, permanent wealth, not subject to +the vagaries of fashion or sentiment. + +Money at call and short notice is nearly as much--over five and a +half millions. This forms a portion of the loan deposits, and being +callable by the banks practically on demand, they show that a portion +of the deposits payable on demand can also be recalled on demand. The +equivalent of these loans, or deposits, the bank possesses in the +shape of wealth not in the absolute category of legal tender. They are +securities of the highest class, securities representing the credit or +wealth of the nation. While these securities are lying in the safes of +the banks they have been converted into temporary currency, and have +been fulfilling all the purposes of money in circulation. They have +been resurrected from dead into live capital. A similar process could +be gone through by selling the securities in the market. The owner +could convert them for his purposes into liquid capital. But he sells +them temporarily to the bank instead of permanently in the market, +and when he has employed his liquid capital temporarily, he repays +it to the bank. He rechanges it, as it were, into dead or illiquid +capital, until the moment comes when he desires to reconvert it into +live capital, or currency. The bank possesses the wealth in bonds; he +possesses the wealth in currency, and the bank’s gain consists of the +interest on the accommodation, and his gain in the profit accruing from +the active employment of his capital. + +There is no more trust than a butcher has when he sells a leg of +mutton for 4_s._ 6_d._ on the nail. His dead leg of mutton he converts +into live legal tender currency. If he never sold his mutton he would +starve. If the housewife’s husband earned no more salary wherewith to +exchange it for future legs of mutton they would starve. + +If the banker lent the borrower money without security, it would be +more truly credit, for he would have no wealth that was the equivalent +of the loan. + +If he, at certain seasons, is compelled to call in these loans to +bill-brokers and others and cannot renew them--quite a frequent, +familiar operation--those who want to convert their dead wealth into +currency go to the Bank of England. Machinery similar to that employed +in the joint stock banks is put into operation there. The Bank takes in +the securities, debits itself with the amount it empowers the borrower +to withdraw in currency, and credits itself, not with words, but with +valuable bonds. It insists that these bonds shall be of the highest +value, and this insistence is inconsistent with the idea of what the +ordinary man regards as giving credit. Otherwise, there would be +greater trust in promises than in securities. + +The objection borrowers have in going to the Bank of England is, they +have to pay more for the services rendered. In the phraseology of +Lombard Street, they have to pay higher interest for their loans, and +being ordinary mortals, not too full of the milk of self-sacrifice, +they prefer to go where they can deal more cheaply. This is precisely +the motive that sends the housewife to the cheap butcher. She might get +her leg of mutton a farthing a pound cheaper than if she went to the +dear, extortionate butcher. + +And there are some people in the City who have whispered that the +Bank of England is extortionate. And those who have listened to them +have made grimaces not altogether unlike expressions of sympathy and +agreement. + +Still keeping our attention on the balance sheet, and turning it for a +moment from the stern, unbending business men at the Bank of England, +we find that the legal tender and the call loans total over eleven +millions and a half, and the deposits are thirty-seven millions and a +half. + +Next, investments exceed £6,000,000. The balance sheet says these +investments consist of Consols and other securities of, or guaranteed +by, the British Government, Indian, Colonial, and other securities. + +I do not think any critics, not even financial journalists--for do not +the public ask their advice what to invest in?--will deny that here we +have the cream of investments. We could not, not the brainiest critic +of us all, imagine anything creamier. Why, these are the creamiest +things that make a hungry City editor’s mouth water. I dare say the +most humble of them would confess that if a kind-hearted employer would +only give him a few thousand pounds’ worth, he would not waste his +intellectual resources in writing another line of financial criticism. +He would be so content with this wealth that he could till his +death-moment repose in absolute idleness and enjoy contemplation of the +continued labours of less fortunate City journalists. + +Here, then, is an aggregation of approximately £18,000,000 of +first-class wealth, or nearly 50 per cent. of the total pure and loan +deposits. + +Bills discounted approach £7,000,000. I need not spend much labour in +analysing and describing what bills of discount are. Those who wish a +detailed description must consult other works dealing more fully with +elementals. It is sufficient to say here that these bills represent +also the best class of wealth, distinct, of course, from gilt-edged +securities, but wealth, nevertheless, of the highest character. They +represent produce, raw materials, manufactures of a vast and varied +character, and when the bank has in its possession these bills which it +has discounted, it practically has the varied wealth they represent. + +Cheques are to be regarded as our national currency, bills of +exchange are to be regarded as international currency. Cheques are +wealth converted into national currency. When a bank discounts bills +it enables them to perform also all the functions of our national +currency. Until they are so discounted their functions are limited to +their international purposes. + +This is one of the purposes served in re-discounting them with the +joint stock banks. + +The great bill-broking firms and discount houses discount them on +behalf of customers and re-discount them with banks. It is in the +re-discounting that they make their profits and continue their +existence. They cannot tie up their capital in these investments. +They must re-discount them in order to liquefy them and restore their +capital. And all the vast wealth behind the bills thereby becomes +liquid capital that can continue fructifying instead of becoming +stagnant. + +Now this wealth, I say, the banks indirectly possess. It is theirs. +They buy it. And if they buy it and it comes into their possession and +they exchange money for it, as merchants and tradesmen do, how do they +grant credit? When the wealth is eventually sold the proceeds go into +the coffers of the banks, and the banks hand over the promises to pay. +But the promises to pay are more tangible than the promises of the +schemer who flits from suburb to suburb and town to town living on what +is called credit. + +Then there is the other composite wealth amounting to over £16,000,000. +These are advances to tradesmen, merchants, and other persons well +known to bank managers, who deposit some kind of wealth as security. + +They are loans to all sorts of people who have pledged all sorts of +wealth with banks. This wealth, in other words, they have liquefied and +the banks have been paid consideration for liquefying it. People have +parted with the wealth, sold it, if you like, and it has been passed +over into the possession of the banks. + +Adding these to the other loans we make a total of nearly £22,000,000, +which compose that portion of the deposits which we call loan deposits. +If we add the bills discounted as another form of loan the total is +raised to £28,700,000 out of a total of £37,600,000 of deposits. This +leaves a residue of £9,000,000 of pure deposits against which the bank +holds £6,000,000 of legal tender, or over 60 per cent. If we add the +£6,000,000 of investments, the total considerably exceeds the aggregate +of the pure deposits. + +Ought the position to be made clearer to the public, to the +unsophisticated man in the street, by segregating the deposits and +showing their component elements? What is the objection? Will some +great bank start reform in this direction if it be earnestly and +sincerely desired to show the public exactly what the position of +affairs is; if it be sincerely desired to surround the groping man +in the street with a bright light? Why not extend reform here after +commencing with the segregation of a bank’s legal tender reserve? + +I can imagine, however, that the refusal would be strenuous. + +Are the pure deposits credit? If they are not credit, entirely distinct +from the loan deposits, but consist of money in some form or other +lodged with the banks, they cannot form a part of what is described +as the credit superstructure of the banks. The so-called credit +superstructure must be composed, then, of the loan deposits which are +at one and the same time loans by the bank, and loans to the bank. If +they are other people’s liabilities and at the same time the bank’s +liabilities, whose credit are they? The borrower trusts the bank and +the bank trusts the borrower; whose credit comes first? Who is the +first creator of the credit? It is as difficult to answer as the +question which came into the world first, the egg or the chicken? + +No matter how we answer the conundrum, it seems to me indisputable that +what we gaze upon is a superstructure of wealth. And it is indisputable +that the banks furnish machinery vital to the progress of humanity. And +it seems to me vital to the interests of national well-being that every +resource should be ready to prevent the collapse of any sound banking +establishment. + + + + +CHAPTER VII + +WHAT IS THE LOANABLE FUND? + + +The loanable fund in Lombard Street is said to be the totality of the +deposits in the possession of the joint stock and other banks, plus +the deposits in the Bank of England. We will, however, for the moment +leave out the Bank of England as being immaterial in the present stage +of our argument. Let us confine ourselves to the deposits in the joint +stock banks, and let us assume that these total £800,000,000. What is +called the loanable fund, therefore, is a mass of money aggregating +£800,000,000. If a merchant or any other person desires to get a loan +he gets a portion of this huge sum, and the commerce and industries of +the country are financed thereout. + +It has been likened by the imaginative to a vast reservoir of money, +into which money is constantly flowing from many channels, and out of +which it flows into a great number of channels. In fact, these channels +form a mighty network, like the veins of the human body, and as the +steady flow of blood to all parts of the body is essential to health +and life, so the steady flow of money throughout the economic organism +is essential to its health and life. + +It is indisputable that money or capital, however we designate the +element, is vital to the well-being of the economic organism of the +State. Without this provision the organism would in time decay and +perish. Therefore some perennial source of this life-giving and +life-preserving element should be provided by the Government or some +other organization if the nation is to thrive and progress. As the +Government has not hitherto provided that source, and as the banks +alone provide it, let us examine the peculiar character and essence of +that element. + +We have seen that this so-called loanable fund, or reservoir of +capital, consists of money hoarded with the banks by the public and +loans by the banks to other members of the public. These deposits are, +in fact, representative for the most part of fixed capital. It is the +habit to call them mere book entries, intangible and invisible, and +that the only sign of their existence are the figures written in the +books of a bank. + +I have endeavoured to show, however, that so far from being intangible, +they are tangible, because they are the composite wealth of the +community in possession, not of the community, but of the banks. It +follows, therefore, that the loanable fund of the country does not +consist of an intangible something called credit, book liabilities, +but of a certain portion of the wealth of the country. + +Now this must necessarily be so. Wealth is the source of wealth and +the fruit of wealth. If you use wealth you produce wealth. We call +the product wealth, or capital, the terms being interchangeable. +Capital is wealth, therefore wealth must be capital, and if the banks +possess wealth they possess capital. Wealth or capital is valued in +the terms of money. We know of no other terms than money for valuation +purposes. If we say a pound of cheese is worth a pound of tobacco, we +mean nothing unless we make simultaneously a calculation by the common +standard of value. + +The cheese is worth sixpence, we say, or one-fortieth of a sovereign, +and the tobacco is worth sixpence. If I borrow sixpence from the +cheese-monger and give him my tobacco I create a loanable fund, for +I can lend the sixpence to some one else for half a pound of tea as +security, and the third person can lend it to some one else, and so +on _ad infinitum_ till the sixpence drops down a deep well and is +lost. Though the sixpence be destroyed the wealth it has created in +the course of its existence is not destroyed, for we assume that it +has been used profitably and fructifyingly in the hands of successive +borrowers. + +If the wealth of the country constitutes the loanable fund, it is +possible to make this wealth fruitful only by converting it into +currency and making it flowable, or liquid. We know that a stagnant +pool will not irrigate land. We know that it must be made to flow along +innumerable channels. The pool of water is as unfructifying as fixed or +stagnant capital. In order to make fixed capital flow and enrich the +area through which it passes it must be re-converted into its original +substance, currency. Fixed capital is rigid currency, as ice is rigid +water. It is frozen. Well, the banks merely unfreeze it, or thaw it. It +is a misuse of language and terms to describe this thawing process as a +creation of credit. + +Now the Government does the same thing when it issues its war loan. It +unfreezes fixed capital; it starts into fruitful circulation hoarded +capital. A similar effect follows other loans and other promotions. +The Bank of England does precisely the same thing when it unfreezes +gold direct from the mines by giving notes for it. The gold is fixed, +or rigid, frozen capital. It is useless for fructifying purposes of a +certain character, and in order to make it fructiferous, or fruitful, +it has to be submitted to the reconversion process. When it has gone +through this process it is able to perform exactly the same functions, +or the same services, as the conversion of other wealth into currency +by the banks. + +How is it that in one case the Bank of England is said not to create +credit, and in the other case the banks create credit, when the two +processes are identical? Because, we say, the Bank of England gives +legal tender currency for the gold, and the banks give only custom +currency for the wealth. The one is not exactly a loan, it is argued, +but the other is. + +If gold were a commodity, just ordinary wealth, would it be a loan +then? The answer is that gold is not a commodity. But we know that gold +is a commodity until it has been minted into sovereigns. As an ordinary +export and import it is a commodity. + +But, the answer comes, the notes are legal tender and legal tender is +not credit. Here comes in the schism, the casuistry. Fundamentally, +the argument is this. The conversion of wealth into ordinary money or +currency is credit, the conversion of wealth into legal tender is not +credit. + +As the banks lend, therefore, something over and beyond the exact +amount of legal tender they possess, they create credit. If they lend +only the sum equal to their legal tender they do not create credit. +Therefore, credit is a something not inherent in legal tender. + +Now pure deposits are loaned to banks. Therefore the pure deposits, if +they are credit, are the credit of the depositors. If I exchange gold +for notes at the Bank of England and deposit those notes with a bank, +the bank has not created these notes and, therefore, has not created +credit. And the legal tender notes are, as I have already said, no +part of the structure of credit. The legal tender notes are loaned +to borrowers, or exchanged for other people’s wealth, and in ordinary +business transactions there is no credit when there is equal exchange. +Credit comes in when there is no direct exchange, or when there is +unequal exchange. + +No wonder the views on this complicated problem are irreconcilable. I +may recall what Mr. A. C. Cole, a director of the Bank of England, said +years ago, in an argument between him and Mr. Tritton, the President of +the Institute of Bankers. + +“Now, I was very much surprised, on reading Mr. Tritton’s paper, to +find him stating that the commonly accepted opinion that a bank can +create credit is a pure fallacy. In my opinion, if a bank does not +create credit, it cannot make a profit; in fact, it is by the creation +of credit that banks earn their dividends. While I was surprised at +the above-mentioned statement, I was equally surprised to find that a +number of the bankers who took part in the discussion which followed +his paper seemed to accept the statement as correct.” + +Banks seem to me to make their profits by taking a share of the profits +earned by the merchants and tradesmen of this country. The profits of +the country are divided, as we all know, amongst the capitalists, the +retailers, and the working people. If there were no such division of +profits industry would come to a standstill, and the community would +starve. The producers share their profits with the consumers, and the +consumers with the producers. It is impossible for one branch of the +community to amass all the profits and the other branches to have none. + +The banks form one branch of the community that takes a due share of +the aggregate profits of the community. + +The banker says _de facto_ to the merchant who borrows from him: “I +will help you to make your capital liquid so that you can continually +earn profits by the use of it, if you will remunerate me by giving me a +portion of your profits.” The merchant readily agrees to the bargain, +knowing that it would be a bad bargain for him if he did not earn +with his mobile capital larger profits than he would hand over to the +bank. If he makes ten per cent., say, he gives the bank two or three +per cent. If the bank made no charge for its services, the merchant +would then have the greater part of the ten per cent. The merchant is +the middleman between the capitalist--that is, the banker--and the +consumer, and the middleman gets the profits of the middleman. Unless +the bank provided him with the capital he would be helpless. + +It will be seen, therefore, that a bank’s profits are not something +over and above, out of the sphere of the total profits of the +community, but are a share of them, just as my employer shares with me +the profits he makes. If he paid me no salary, his personal profits +would be larger. But they are diminished to the extent of the salary he +gives me. + +When banks raise their interest for loans it is tantamount to raising +the price of their services. That is to say, they demand a larger share +in the profits of the community. Merchants then try, in their turn, to +obtain a larger portion of the profits of the community. + +Less wealth is then liquefied, the wheels of trade begin to revolve +more slowly, and depression sometimes begins. Profits diminish, less +capital and wealth are produced, and the effect is subsequently seen in +the so-called loanable fund. + +The character of the loanable fund alters, however, in times of +depression. The pure deposits then increase and the loan deposits +diminish. As it becomes less profitable to liquefy fixed capital, then +less wealth is taken to the banks to be liquefied, and therefore the +banks have to take their lessened share of the aggregate profits of +the community. But a considerable portion of capital already in liquid +form in the shape of profits, instead of being reconverted into fixed +capital, remains liquid, and in its liquid form is hoarded with the +banks. But this hoarded, liquid capital is not credit now, although +in its origin it was called credit. Even those who hold that banks +originally created the credit will hardly deny that these deposits +are now money, even though the money may be the product of former +bank loans, or former liquefaction of wealth. If in their original +liquefaction they were credit, why are they not credit now? At what +precise moment did they become no-credit? If they originated as credit +why are they not permanent credit? + +However, we see the character of the loanable fund change. The pure +deposits grow, the loan-deposits diminish, and banks are said to have +more money or capital than they can employ. This is so, even if the +aggregate of the deposits is precisely the same before the depression +as after it, the increase in the pure deposits being, say, merely equal +to the decrease in the loan deposits. + +Why, if the deposits are equal in amount, is the loanable fund much +greater in times of depression than in times of activity, and why do +rates for loans fall? + + + + +CHAPTER VIII + +THE METAMORPHOSIS OF THE FUND + + +This is because of the character of legal tender currency, and a legal +tender currency, however desirable and however great its merits, must +necessarily have its shortcomings in a progressive state. + +The loanable fund is restricted, or controlled, not by the growth of +the country’s wealth, but by the production of gold. To control it +by so artificial and arbitrary a circumstance as the output of gold +may seem absurd, and from a strictly logical and economic standpoint +it is absurd. The loanable fund ought to be governed entirely by the +production of wealth, and not by something entirely independent of +wealth and having no natural or economic connection with it. + +I am now speaking of the loanable fund which collects in the joint +stock banks. Of the other loanable fund, which collects in the Bank of +England, I will speak later. + +What the banks lend is liquid wealth, but the amount they can lend +at any given moment is governed less by the amount of wealth that is +brought to them than by the amount of gold they possess. This is the +gold which, we say, constitutes their reserves. + +Let us assume that it is the custom of the banks to keep a gold, or, +rather, a legal tender reserve--it is chiefly composed of Bank of +England notes--equal to fifteen per cent. of their combined pure and +loan deposits. It follows that the growth of these deposits must be +controlled by this fifteen per cent. reserve. This is so in practice. +When the reserve begins to fall below this fifteen per cent., then the +banks cease liquefying wealth and increasing the loan fund. When the +reserve increases beyond the fifteen per cent., then the banks continue +to liquefy the wealth. + +It is then said that money--some say credit--is abundant, and the banks +cannot find full employment for it. When the reserve falls it is said +that money--or credit--is becoming scarce. We find, therefore, that the +loan-fund actually contracts when trade is active, and expands when +trade is depressed. In the economic interests of the nation the fund +should grow simultaneously with and commensurately with the growth of +trade and commerce. + +In times of activity more wealth is created. It is like an abundant +harvest resulting from a favourable season. In times of inactivity less +wealth is created, to be likened to bad seasons and poor harvests. +In times of activity there is necessarily and inevitably a greater +demand for capital, that is to say, for more liquefied wealth. Bills +of discount multiply, and they are taken to the banks as security for +loans, in other words, to be converted into liquid form. Another phrase +is, into floating capital. If they could not be so converted, the needs +of the community in such times could not be met, for the bills of +discount could not be used as currency, or capital, like cheques. They +are discounted at the banks in order that they may be transformed into +cheques, the representatives of floating or circulating capital. In +this form they are able to reproduce wealth more rapidly than if they +had to remain in their original form. + +So it is with other forms of wealth, all are taken to the banks to be +converted into quickly reproductive shape. + +But the banks have to keep an eye on that gold reserve, watch it +closely. Managers have to calculate when the limit of their conversion +powers will be reached, and when it is reached their wealth-liquefying +machinery has for the time being to cease working. It does not follow +that when the machinery of one bank has to stop, the machinery of all +the banks simultaneously stops. The limit may not yet have been reached +in other banks. Borrowers, as they are called, then rush to them, and +as the numbers grow and the pressure increases, so is the limit of the +other banks more speedily reached, until at last the entire machinery +comes to a stop. It often comes to a stop when in the interests of the +economic welfare of the nation it should be working most actively. + +But the machinery is controlled by another independent agency, and +the economic interests of the nation must suffer the effects of this +obtrusive force. + +If this independent force be at times harmful and not beneficial to +the economic welfare and progress of the nation, what is to be said +of the cry that this force, in the most urgent times, should be made +more interfering and harmful? What is to be said of the cry that at the +moment when the need is greatest then the succour should be restricted? + +What should we say of the doctor who by ligatures prevented the free +flow of blood in the body of an active, energetic man, in order to +paralyse his energies and enforce rest? We should say that he was not +only an unscientific doctor, ignorant of the functions of the bodily +organism, but that he was actually killing his patient. These gold +reserves, therefore, act like ligatures, for they stop the free and +health-giving flow of economic blood at the very moment when the flow +should be stimulated. + +In inactive times we see the metamorphosis of the fund take place. The +loan deposits decrease, because the liquefied wealth becomes frozen +again and the production of wealth decreases, while the pure deposits +grow. The fact that the loan deposits decrease simultaneously with +the contraction of wealth production is an additional proof that the +loanable fund is wealth in liquid form. As the wealth in fixed form is +withdrawn from the bank so the loan deposits drop. + +Now the increased pure deposits may be regarded as a portion of the +harvests gathered from the fructifying use of the liquid capital in +times of activity. They are called the profits, or the savings of +capital. They accumulate in times of depression. For lack of other +employment they are placed on deposit with the banks. They are, in a +way, loaned to the banks, and the banks are supposed to lend this money +to the classes of borrowers already described. But the banks at these +times benefit, or are presumed to benefit, not because the aggregate of +the deposits grow enormously compared with other periods, but because +these pure deposits bring them more gold. The loan deposits take gold, +the pure deposits bring gold. + +This is why, the aggregate being the same, or even less, the potential +loanable fund is greater in inactive than in active times of trade. +The gold reserves increase and the proportion of the reserves to the +aggregate deposits rises. When this proportion rises, the banks say +they can afford to let it fall, and therefore they can liquefy more +wealth if there were more wealth to liquefy. But there is less wealth +to liquefy, and therefore money is now said to be abundant and cheap. +The banks are willing to take less interest, that is to say, a smaller +share of the profits earned by liquefied capital. + +But depositors also have to take a smaller share of these profits. +The banks divide their smaller share of the profits with the pure +depositors, and, therefore, can give only a smaller rate of interest +on the deposits. Dissatisfied with this small rate of interest, +depositors seek for other channels of use, other forms of investment, +and when they find these other channels, they withdraw their deposits +and reconvert them into fixed or frozen capital. They may speculate +with them in mining or rubber shares, or invest them in Consols or War +Loans. When this is done, gold is automatically withdrawn from the +banks and the proportion may drop. Should the proportion drop, banks +can lend less, and the potential resources for liquefying capital +becoming less, they can begin to charge more for these services. + +When the pure deposits increase the reserve of gold automatically +increases. Therefore, though the risks of the banks increase, because +the liabilities on demand increase, so the power to meet those risks +automatically increases. This being so, the necessity for increasing +gold reserves is less apparent; for they increase automatically. +When the pure deposits decrease and the loan deposits increase the +proportion falls, but it falls at a time when the risks are lessened if +set against the pure deposits as distinct from the loans owing to the +bank. + +It will be seen, therefore, owing to the constantly fluctuating +character of a bank’s liabilities, or risks, it is impossible to +maintain a fixed, undeviating reserve, whether it be a high reserve +or a low reserve. And we know that this impossibility is demonstrated +every day in Lombard Street. + +It is demonstrated at the end of each month, when the banks cease +lending, and when they compel their loan depositors to pay in their +loans. This is proof that a proportion of the deposits are loans to the +bank. As these loan deposits thereby contract, banks cannot compel the +pure depositors to withdraw their deposits, therefore the proportion +of the gold reserve to the _whole_ rises, and the wish of those who +clamour for high reserves is fulfilled. + +This policy is resorted to because an idea exists amongst bankers that, +instead of going to theatres and other places of amusement, the public, +as a body, spends its leisure time during the closing days of each +month working out the proportion of the reserves to the total deposits. +This is a fantastic dream. The public does nothing of the kind. It is +fallacious to imagine the public working out the proportions minutely +and then deciding in strictly mathematical fashion whether a bank is +safe or not, and whether there is likely to be an immediate run upon +it or not. If bankers and theoretical financiers were only gifted with +the power to understand human psychology there would be less contention +amongst them on questions of pure theory. They would not magnify the +unimportant at the expense of the important functions of banking, and +magnify the superficial at the expense of the deep traits of British +character. + +We see the same policy adopted at the end of each half-year, or year, +when the banks make up their half-yearly or yearly balance sheets. +Such a great deal has been made of this high reserve need--as though +it were possible for any mortal being to draw up an absolute line +of safety--that at these periods trade is penalized because bankers +imagine that the millions of this nation are auditing their accounts. +They see them poring over these accounts in the great castles of the +realm, and in the cottages of the poor. It is a pure delusion, and +if the millions engaged themselves voluntarily in these uncongenial +tasks, the result would only be national confusion, and not national +agreement. There can be national agreement on one thing connected with +the banking system, and one thing only, alike in the mansion and in the +cottage, and that is agreement upon the honesty and soundness of that +system. And honesty and soundness are not to be tested solely by the +bulk of the legal tender reserves. + +The only members of the community who, perhaps, might be more concerned +than others about these reserves are the very members who share the +responsibility equally with the banks. They are those who borrow from +the banks, who get their liquid capital there. All they have to do is +to cease borrowing, cease converting their wealth into currency, and +the thing is done. The remedy is in their hands. + +Do they do this? No. Do they show this feverish concern? No. What do +they do? These men, who have more at stake than the other millions, +actually growl when the banks refuse to liquefy their wealth. They +make it a grievance, and a sore grievance. To imagine, therefore, that +these growlers are watching minutely the movements in the reserve is a +delusion verging near to absurdity. + +When some bank managers tell borrowers they must repay their loans, +then they rush round to other bank managers, caring not a fig about +reserves so long as they can get the accommodation they want, for their +needs are above all other considerations. And when they find that no +bank manager will serve them, and when all bank managers tell them they +are sold out, then they have to go to the Bank of England. They do not +like to go to the Bank of England, because they have to pay more for +the services that Bank renders. That is to say, they have to share with +the Bank of England a larger portion of the profits they make than the +portion they would divide with the joint stock banks. + +By this analysis we see that the deposits of a bank, the so-called +loanable fund, consists of pure deposits, which we may call cash +deposits, and loan-deposits, which those who believe in credit creation +call credit deposits. These latter deposits represent the wealth +placed with the bank, and so long as this wealth is in liquid form in +these deposits it cannot be employed in its fixed form. These deposits +are loans owing by the bank and owing to the bank. Others call them +credit deposits created by the banks themselves. + +These loans are made in relation to the proportion each bank is in +the habit of maintaining between its cash, or legal tender reserves, +and the deposits as a whole. The loan deposits increase or decrease +according as this proportion rises or falls. + +It is left to the discretion of each bank to decide what the proportion +shall be. There is no legal compulsion. Therefore it is their practice +to retain the minimum ratio which they consider sufficient for their +safety. When this safety limit is passed, then they stop lending +and proceed to call in their loans. The totality of the deposits +automatically diminishes, and though not a sovereign has been added to +the reserve, the proportion rises. + +This, then, is the important point. Not so much the amount of the +reserve, as the proportion. One bank may have fifty millions in its +reserve, and another bank only fifteen. But the smaller bank may have +a higher proportion to its liabilities and the larger bank a smaller +proportion. The test, therefore, if there must be a test, is the +proportion of the reserve to the total liabilities, and with this I +shall deal more fully later on. + + + + +CHAPTER IX + +THE CENTRAL FUND + + +What I call the Central loanable fund is the fund in what financial +journalists call the Central Institution. This is not to be regarded as +an institution standing in the centre of a great circle of banks, with +directing chords, as it were, radiating from this governing centre. +Why it is called the Central Institution I do not know, except it +be a birth of the mother of invention, or a need arising out of the +limitations of the English language. + +But the origins are unimportant. The Bank of England, let us say, +stands in an unique position, and it is a banking institution that +possesses great, but not absolute, autocratic powers. The public +attribute to it greater powers, and surround it with a greater glory +and majesty than it probably possesses. This is a psychological fact of +significance. It is the Bank _of England_. That is _the_ Bank; the Bank +that props up the nation, and which the nation in its turn props up. +It is a mutual propping up. The one cannot fall headlong and leave the +other standing erect. Both must stand or fall together. As, however, +in the consciousness of the community the nation is unshakable--then it +follows that the Bank of England is in the nation’s view unshakable. + +Let me say, before I proceed further, that there is no delusion in +this. It is a fact of tremendous import. + +Where a delusion does exist is in the belief or consciousness that +the Bank of England is a State bank and not a private bank like other +banks. It is, however, a private bank, like other banks, performs +similar functions, earns its profits in the same way and distributes +its dividends to its shareholders in the same fashion. It is a +proprietary establishment, run by the directors for the benefit +primarily of its shareholders. + +It is only a State Bank in that the Government deposits its funds with +it alone, borrows from it now and then, and employs the Bank as its +medium for issuing loans, paying interest on the funds and performing +many other functions on its behalf. These functions, it need scarcely +be said, are not performed gratuitously. They provide a source of +income for the Bank. + +The Bank of England is also a banker for the private individual in the +same way as an ordinary joint stock bank is. + +It is also the banker’s bank. It may seem strange to some people to +learn that the banks themselves have a common bank. This common bank is +the Bank of England. But they bank with it in a strictly limited way. +They do not borrow from it, nor discount or, rather, re-discount bills +of exchange there. The Bank of England is to the joint stock banks a +limited convenience. + +They deposit what is called their reserve funds there. In the balance +sheet we have examined we see that that particular joint stock bank +possessed in coin in hand and at the Bank of England a sum aggregating +£5,996,668. How much it had in its own safes and how much at the Bank +of England, no outsider can divine. At any rate, we learn that a +portion of it was in the keeping of the Bank of England. + +This reserve performs two functions. It acts as a part reserve against +deposits, or liabilities, and it helps in adjusting the balances +between the various banks, the adjustment being made in the books of +the Bank of England. + +I need not describe here the methods of the bankers’ clearing house, +how each day the cheques are cleared, and how each bank at the close of +each day finds out how it stands in relation to the other banks. Debits +are settled, not by a direct transfer of cash, but by drawing a cheque +upon the Bank of England, just as an ordinary individual redeems his +liability by handing to his creditor a draft on his bank. If they both +bank at the same bank the necessary adjustments are made in the books +of that bank. The aggregate deposits of the bank are unaffected, and +the reserve is unaffected. + +All the joint stock banks, then, have accounts with the Bank of +England, and the deposits of the Bank of England include reserves of +the joint stock banks. The Bank of England pays no interest on its +deposits. + +Let us now analyse a Bank of England return, which we may call a Bank +of England balance sheet. The following return is a post-war return, +issued some months after the outbreak of the war:-- + + +BANK OF ENGLAND. + + +ISSUE DEPARTMENT. + + £ | £ + Notes issued 86,802,605 | Government debt 11,015,100 + | Other securities 7,434,900 + | Gold coin and bullion 68,352,605 + | Silver bullion + ---------- | ---------- + 86,802,605 | 86,802,605 + ========== | ========== + + +BANKING DEPARTMENT. + + £ | £ + Proprietors’ capital 14,553,000 | Government securities 21,824,358 + Rest 3,499,722 | Other securities 108,836,570 + Public deposits 47,393,479 | Notes 52,098,065 + Other deposits 117,593,833 | Gold and silver coin 813,512 + Seven day and other | + bills 32,471 | + ----------- | ----------- + 183,072,505 | 183,072,505 + =========== | =========== + +We must leave out of consideration for the present the Issue +Department. This is quite distinct from the Banking Department, and +so far as the Banking Department is concerned, its working is as +independent as though it were merely a Treasury Office in Whitehall. + +The Proprietors’ Capital explains itself. It represents the amount of +capital subscribed by the shareholders. The Rest may be regarded as the +Bank’s accumulated profits, and ordinary reserve fund. It is the fund +into which the profits flow and the funds out of which the dividends +are paid. It is not allowed, however, to run below £3,000,000. + +The Public Deposits are the Treasury deposits, and it will be observed +that these are kept distinct from the Other Deposits. As every return +explains, these deposits include Exchequer, Saving Banks, Commissioners +of National Debt, and Dividend accounts. When we pay our income tax +to the Government it is paid into the Bank of England and swells the +Public Deposits, and the Government uses them in the same way as the +private individual uses his deposits in his own bank. + +The Other Deposits are the aggregate deposits of all the Bank of +England’s depositors except the Government. They include the Reserves +of the banks of the Kingdom and the loans the Bank has made to its +various customers. As they include loans they are a composite account. +The Seven Day and Other Bills is an item of no importance. + +On the other side are the assets the Bank holds against these varied +liabilities. Government Securities are securities lodged by the +Government as a security for loans, and they also include the Bank’s +own investments. The Other Securities include bills of discount, and +securities of the highest class lodged with the Bank as security for +the loan-deposits. + +The notes are the ordinary Bank of England legal tender notes, and +constitute, with the small amount of gold and silver coin, the Reserve +of the Bank against its liabilities. In this particular week the ratio +of the Reserve to the liabilities was 32⅛ per cent. + +It will be noted that the Reserve does not consist of coin, but +almost entirely of notes. But the notes can be exchanged at the Issue +Department for gold, so that they are equivalent to a holding of gold. + +On the asset side of the return, then, we see the character of the +wealth the Bank possesses. This wealth represents the loanable fund of +the Bank and totals a huge sum. The deposits are, of course, merely +book entries, or book liabilities, or credits, as most call them, and +what I call the liquefied form of the wealth held against them. + +Those who borrow the most extensively from the Bank are bill brokers, +and they only borrow in those seasons when the joint stock banks have +reached the limit imposed by their reserves and cease lending. Having +need of liquid capital and not being in a position to wait until +the joint stock banks can lend again, it is with great reluctance +the bill brokers borrow from the Bank of England. The reluctance is +most natural, because the Bank of England charges higher rates for +discounting bills and for lending money on security than the joint +stock banks charge. And it also discounts and lends for much shorter +periods. This explains the Bank rate, which is of such great importance +in the economic life of the nation. It is the minimum rate at which it +will discount bills for customers and the brokers, while it will lend +only at half per cent. above its minimum rate for discounting. + +The rates charged by the joint stock banks are always well below Bank +rates, except on the rarest of occasions, and therefore bill brokers +and borrowers of money generally naturally go to the cheapest market, +and when they are forced to go into the dearest market in Threadneedle +Street they go there from necessity and not from choice. + +We are able now to grasp in some measure what the Central Fund is. The +Bank of England, when other sources are dried up, is always able and +willing to lend _at a price_. This price is regulated by the calls +upon it, by the state of its reserve, by the condition of the foreign +exchanges, and by a general survey of financial conditions. + +The rate is an instrument for limiting borrowing, for correcting the +foreign exchange, for drawing gold to England, and for replenishing +its reserve, if the proportion has fallen to what is considered below +the average ratio of prudence, or safety. + +The loanable fund of the Bank of England, therefore, is identical with +the loanable fund of what is called the outside market. It is the +highest class of wealth liquefied, but to the Bank is given the sole +power of attracting gold from abroad as a basis to this fund when that +gold is needed. + + + + +CHAPTER X + +THE CENTRAL RESERVE + + +The Central Reserve is the reserve held by the Bank of England. Not +only is it the Central Reserve, but it must be regarded as the National +Reserve, the sole reserve. This is regarded by many as the chief +weakness of the banking system. + +Let us first of all distinguish between reserve and reserve. This +Central Reserve is the national legal tender reserve. The joint stock +banks have other reserves, as we have seen, composed of the highest +wealth in the kingdom, and though there may be some reason, there does +not appear to me to be the soundest, deepest reason why the foundation +of the system should be considered unsound because of our moderate +legal tender reserve, dependent as it is upon independent forces, and +because we place minor importance upon the country’s store of wealth. + +To me it would seem the soundest reason to plant our banking system +chiefly upon the solid basis of wealth, and not let that system be in +the capricious control of a force that has no direct connection with +the country’s real wealth, especially when we have now found it to +be easily possible to meet that most remote contingency, a national +panic. The nation lives like a parent whose obsession is that in some +far-off day his son may meet with a serious accident that will affect +his brain and make him an imbecile. What will he do, then, when his son +becomes mad? He broods over the possibility; it darkens his life; it +keeps away joy and happiness; his health suffers; his energies, mental +and physical, become paralysed, and death gathers him while his son is +still in the prime of healthy manhood. + +After all, what panics have we had in this country? Not one but what +has been quickly assuaged since the banking system developed into its +present stage of soundness. + +As it is insisted in many quarters that the system is far away from +being sound enough simply because we have not large enough gold +reserves, we must examine the national reserve from this point of view. + +This reserve is not only the Bank of England’s reserve against its +own liabilities, but is the reserve against the aggregate liabilities +of all the banks of the kingdom. The joint stock banks, as has been +explained, keep their reserves at the Bank of England, the gold they +keep in their tills and in their strong rooms being too small to take +into serious consideration. + +If we take the average fluctuation of the Bank of England’s reserve +to its own liabilities as from 40 to 50 per cent. throughout the +year--this is quite a fair average variation of the proportion,--we +should probably find that the proportion of this reserve to the total +liabilities of all the banks would be as low as from 1 to 3 or 4 per +cent. This is, of course, a very low proportion, but low as it is, +it has served us well enough in the past, and as we cannot ignore +experience, it should continue to serve us well in the future. + +When the proportion, say, falls below 40 per cent., and is approaching +30 per cent., the Bank of England takes steps to restore it to what is +considered the normal or prudent level. + +The proportion, as is inevitable, begins to fall as borrowers are +driven to the Bank of England when the joint stock banks have ceased +giving accommodation. Though not a single note may be withdrawn from +the reserve the proportion must necessarily fall as the liabilities +rise. But it by no means always follows that when the proportion +falls from this cause alone the Bank will raise its rate. This will +depend upon general circumstances. There will be no need for the step +if general circumstances are favourable, for the loan-deposits will +in time be paid off and the normal conditions of the market will be +restored. + +As a fact, nothing is more familiar and certain in Lombard Street than +these recurring phenomena. At the end of quarters, especially the March +quarter, when the taxes are flowing into the Exchequer, there is a +considerable amount of borrowing from the Bank of England. When the +money flows back into the market through Treasury disbursements, the +borrowers are able to repay their loans to the Bank. + +In these times we see the Bank’s liabilities grow in twofold fashion. +The Public Deposits grow owing to the tax-ingathering, and the Other +Deposits grow because of the borrowing on the part of what is called +the outside market. At the same time, a counter-active influence is at +work. As the taxes are paid in to the Government they come indirectly +out of the Other Deposits, because they come out of the deposits of the +joint stock banks and out of their reserves, so this puts a check upon +the growth of the Other Deposits. + +The Bank of England generally raises its rate when a large export of +gold abroad takes place. There are two main channels through which gold +flows from the reserve of the Bank of England. The one channel is that +which takes gold into national circulation, to the provincial banks and +to Scotland and Ireland at certain seasons of the year; and the other +is the channel by which gold is taken to foreign countries. + +The internal drain, as it is called, rarely has any influence upon the +movements of the Bank rate. This is because gold is known to be in the +country, and if it is not in the Bank’s own reserve, it is practically +in the total reserves of the other banks, and it will all return to +the central reserve in due course. + +A foreign drain of gold arises from quite other causes. It will arise +from a complication of causes. Gold may be taken from the Bank in order +to liquidate the country’s balance of debt to other countries. It is +a common phenomenon, for instance, to see at certain seasons of the +year large exports of gold to New York, Egypt, and South America. These +exports are expected, and occasion no surprise. But sometimes they are +supplemented by large unexpected withdrawals, there and elsewhere. + +As an offset to these withdrawals, the Bank can replenish the reserve +by purchases of gold in the open market. Each week gold comes to London +from South Africa and often from India, and if the Bank can buy this +gold it may obviate the necessity of raising the Bank rate. Sometimes, +however, there is keen competition for these arrivals of gold, keen +competition from the Continent or New York, and the Bank may be unable +to outbid its competitors. + +The Bank is bound to take all gold offered to it at the statutory price +of 77_s._ 9_d._ per ounce. But competition will sometimes drive the +price well beyond this figure, and continental countries sometimes buy +the gold at a loss, as Germany did in 1914, if they are determined to +have it at any price. + +For many months before the outbreak of the war, the competition was +exceedingly keen, so keen that for a long period the Bank of England +was unable to purchase an ounce of gold. This competition was chiefly +on the part of Germany and Russia, especially Germany, thereby +affording presumptive evidence of her deliberate plans for war. But +this competition and buying must be regarded as abnormal. + +The normal buying and the normal competition arise when gold is wanted +in the normal course of trading between different countries. If, for +instance, the New York exchange is driven down to such a point that +it is cheaper to send gold than to buy drafts, or exchange, then gold +is bought and shipped. This applies equally when other exchanges are +against this country. + +Sometimes we can spare the gold so well, that it is better to let it +go than to keep it; which proves the futility of having a greater mass +of gold in the country than the country needs. At other times we may +have too little, and cannot spare more, and it is at such times that +another kind of competition starts: the competition of bank rates in +the various European centres. + +The object of raising the Bank rate is to raise interest here. When the +rate is advanced, the joint stock banks immediately raise the interest +they give on their deposits, and the rate of discount simultaneously +rises. The latter, however, is not always instantaneously responsive, +for the rise in the Bank rate may have been foreseen for some time, and +rates may have risen already in anticipation. It is often possible to +judge, in the light of experience, when the Bank rate will be raised. + +The competition takes the form, therefore, of raising rates of +interest; in other words, of making money more remunerative here than +elsewhere. The Continent will probably send gold here, or keep gold +here in order to earn the higher interest, especially in discounting +bills, and therefore the export of gold may be stopped, and gold, at +the same time, attracted here. + +It does not follow that this is the inevitable consequence. This +will depend, not entirely upon conditions here, but may be ruled by +conditions elsewhere. There is no hard and fast rule, no sure working +of the law of cause and effect. If other countries are determined to +have the gold, they will take it, no matter how high the rate may be +raised here, and in latter years the rate has not been so effective, +probably, as in former years. + +Whether it be effective or ineffective at given moments, it is one +means we possess--some call it a weapon--of trying to replenish our +national reserve from other centres, and of increasing the power of the +Bank to buy gold in the open market. + +We do not like the reserve to run down too low, because we fancy that +a low reserve would create too much nervousness in the financial +community. We do not imagine it would create a panic, but it may +prevent undue nervousness should the Bank take measures to stop the +drain. If gold flows here, it will in course of time make bank, or +market money, more plentiful and cheap. + +At the same time, of course, the trade of the country is necessarily +penalized. It is not good for trade that there should be frequent +fluctuations in the price of loans. It affects profits, the growth of +capital, and prices, and it also affects the employment of labour. +If too much has to be paid for bank loans, then it becomes too dear +a process to convert fixed wealth into liquid capital, for users of +capital may not then be able to employ it remuneratively. And this may +be a precursor to trade depression and stagnation. + +If at such times we could replenish the reserves from the provision of +other legal tender, it might obviate it. + +If money be sent here for investment at the higher rates of interest, +it will increase the Bank’s reserve and at the same time increase the +supply of money. As the supply of money from the joint stock banks +is dependent upon these gold reserves, their gold reserves will be +increased. For some of this fresh gold will find its way to the banks. +They can then convert more wealth into currency, and thereby stimulate +trade. + +When foreigners invest their money here, they earn their profits in the +same way as our banks do. Their profits are a portion of the general +wealth of the community. As profits can come only from the production +and consumption of wealth, and not from the void, then they are a +portion of that wealth. And if profits are a constituent of wealth, +even if we call them a residue of wealth, then bank profits must come +from the same source, and not from space. + +Foreign banks, therefore, become possessed of a part of this country’s +wealth, for profits are purchasing power, and purchasing power cannot +be intangible; it cannot be credit. In the same way, when we invest +money in a foreign country--say, Argentina--we receive the interest +in the shape of commodities, that is, in the shape of the country’s +wealth. They are this country’s profits on that loan: something +tangible, something Argentina and her wealth-producers part with, and +something they would retain if they did not send it here. + +Therefore the interest we pay on foreign loans here must also be paid +in wealth. And if foreign bankers get their profit in the shape of +wealth, so must our bankers get their profits in the same substance. + + + + +CHAPTER XI + +THE FIDUCIARY CURRENCY + + +In speaking of the fiduciary currency of the country I will confine +myself for the moment to that portion of it represented by Bank of +England notes. The war-emergency Treasury note currency I will deal +with later on. + +All countries have a fiduciary paper currency. Some have a convertible +currency, others an inconvertible, and others a partially convertible; +but the dimensions of this treatise cannot be expanded by a comparison +of the systems of different countries. Those who desire to be assisted +by comparisons must consult other works. + +Moreover, I wish to confine myself to our own fiduciary currency since +the Bank Charter Act of 1844. Prior to then the banks of this country +were permitted to issue their own notes, and to issue them in unlimited +quantities, with the provision that they were payable in gold on demand. + +There were people who attributed the various crises that occurred in +different periods prior to 1844 to the over-issue of these notes. It +was contended that this alleged over-issue brought about an inflation +of the currency and encouraged gambling and speculation. Diverse views +were held then, and diverse views are likely always to be held, as to +the true origins and causes of financial crises. But whatever the views +or causes may be there can be little doubt, human nature being what +it is, that many joint stock banks abused the powers with which they +were endowed. This privilege of issuing notes to an unlimited amount +is a dangerous privilege to give to irresponsible institutions, and if +the power be given it must be given to responsible institutions or one +responsible institution. + +This view probably was chiefly responsible for the Bank Charter Act +of 1844. This Act provided that the Issue Department of the Bank of +England should be separated forthwith from the Banking Department. +Securities to the value of £14,000,000, which included the Government’s +debt to the Bank, were to be transferred to the Issue Department, +together with so much coin and bullion that the total so transferred +should equal the amount of notes then outstanding. Notes could be +demanded from the Issue Department by any person in exchange for gold +at the rate of £3 17_s._ 9_d._ per standard ounce. + +It was further enacted that if any banker, having the power of issue on +May 6, 1844, should relinquish such issue, the Issue Department should +be authorized to increase its issue of notes against securities to the +extent of two-thirds of the relinquished issue. + +Bankers having the right to issue their own notes on May 6, 1844, +were allowed to continue the issue under certain conditions, and to +an agreed amount; but no provision was made compelling them to keep +any reserve against their issues either in cash or securities. Should +any issue lapse from any cause, it could not be restored, and no +institutions were allowed to acquire the right of issue in the future. + +It will be seen that the fixing of £14,000,000 as the basis of the +note issue against securities, and not against gold, was a purely +arbitrary sum. No matter how it was arrived at, nothing will alter +its arbitrariness, and up to the present there has been no suspicion +of ill, uneconomic results from this arbitrary figure. And being an +arbitrary figure there seems to be no overwhelmingly strong reason why +it should not be extended within judicious limits. We must bear in mind +that in 1844 national and international commerce were not on the mighty +scale they are now. We must bear in mind that the population of this +country and its output of wealth were greatly less than they are now, +and greatly less than they will be in the future, and if this arbitrary +figure was judicious and safe in the first half of the nineteenth +century, and in the second half too, a higher figure should be equally +as judicious and safe half a century hence. + +When we deal with a currency system in an arbitrary manner and control +its workings in an arbitrary way, it is opposed to a scientific way. +A scientific method may be an impossible method in a delicate system +like currency, and therefore, if we must rely upon arbitrariness, this +method can be made elastic and adjustable in a cautious, judicious way. + +In 1844 banking was in its infancy. It has grown since then, but we +cannot with assurance predict what developments are ahead of it, and +fifty years hence the nation may look back upon the present system in +much the same way as we look back to conditions half a century ago. We +find that during the past fifty or sixty years the currency system of +the country has gone through a tremendous metamorphosis. The banknote +system--excepting the legal tender notes--has practically disappeared, +and another paper currency has taken its place. + +This is the cheque currency, the real currency of the country, because +it is representative of the wealth of the country, as currency should +be. It grows with the country’s wealth and shrinks with the country’s +wealth, and this is precisely the automatic function an ideal currency +should perform. A perfect currency should simultaneously expand and +contract with the output and exchange of wealth, because a perfect +currency should be that wealth in liquid form. + +Let us for a moment examine what wealth is. Wealth has been defined +by many economists, and the definitions and formulas have differed +greatly. But we can be more in agreement, perhaps, as to how wealth +actually comes into existence. Wealth is the product of two forces, +and it cannot come into existence unless these forces interact. These +forces are production and consumption. Wealth is not the product of +production only, nor of consumption only. We cannot consume what has +not come into existence, what has not been produced. We can produce +without consumption, but it is consumption that converts it into wealth. + +Articles of merchandise and raw materials are produced in order that +they may be consumed. They would not be produced if there were no +prospect of consumption. It is consumption that confers value upon +products. If products were not converted into wealth they would +perish; they would be valueless. There must be a desire for them. +If there were no desire for them, labour and capital would not be +spent upon consuming them. A desire must exist before production, or +production must bring a desire into being. And when that desire becomes +active, as distinct from passive, its activity becomes consumption. +We know that in states of trade depression the markets are stocked +with unconsumed and unconsumable commodities, and these commodities +cannot, in the strict sense of the idea, be called wealth. They are +perishing, they are valueless, because no one wants them, and vendors +of these commodities face loss and sometimes ruin. They try every art +known to them to stimulate desire for them in order to get that desire +manifested in purchasing them. + +To increase wealth we must necessarily increase production and +consumption; in other words, increase supply and demand. This is the +economic object of all civilized nations. This wealth it is their +object to convert into money, for money is the reproductive product of +wealth. Wealth cannot become reproductive, except in a most limited +sense, unless it is converted into reproductive form, and banks supply +not the entire, but the chief machinery for changing it into this +form. If, therefore, their chief function is to change wealth into +reproductive form, it is not creating credit. + +Money is like the fruit ripened into seed. Fruits of the earth must +be ripened into seed before they can reproduce their kind. If they +perish before then, they do not become reproductive. When this new +seed is sown in the earth, to be gathered into ripened fruit at the +next harvest, it performs the same function that money performs when +it circulates. It reproduces and multiplies itself, and the harvest +springing up from it is new wealth. + +The more wealth, therefore, that is transformed and reproduced and +that multiplies, the richer, we say, a country becomes. Therefore, +it follows that the transforming machinery should work with pace +equalling the creation of wealth if the country is to reap the best +harvests from its work. For every pound’s worth of wealth coming into +existence the means should be provided for transforming it into a +pound’s worth of money. + +So far, the best means discovered is the cheque system. No legal tender +system, based upon gold, could provide these essential means, because +gold is not provided sufficiently, and cannot be provided sufficiently. +The machinery we need can be made with no precious metal. If we desire +perfect machinery, it is indisputable that no machinery could do the +work so efficiently as paper machinery. + +The paper currency system is, therefore, a great advance upon the old +banknote system. It is transformed wealth, and as the cheques represent +the deposits, rising and falling in amount with them, then the deposits +must be transformed, reproducible wealth. The note system, based on no +wealth, was credit. + +Returning to the Issue Department of the Bank of England, we see that +£11,015,100 of the total note issue is based upon the sum of money +owing by the Government to the Bank, and that £7,434,000 is based upon +other securities of a gilt-edged order, making a total of £18,450,000. +The balance is based pound for pound on gold. + +It will be seen, therefore, that if every note was presented to the +Bank to be converted into gold, over £18,000,000 of these notes could +not be converted. Some have suggested that in that event, in order to +provide the gold, the securities could be sold for gold, the Government +debt could be converted into bonds, and they also could be sold. But +as this need could arise only in a panic, when every one clamoured for +gold, and all who had securities were trying to sell them for gold, +the Bank of England would find it impracticable to sell securities for +gold. Such securities, if they are to be sold at all, must be sold at +other times, and the gold must be acquired then if the note issue is to +be made absolutely convertible. + +Personally, I think the need is too remote, too much in the realm +of dreams, to be entertained gravely. The gold could perform better +services to the community than to be hoarded in this fashion. + +Since the year of the Bank Charter Act we have had three serious panics +in the country. Now the Act was passed to prevent panics. As it did not +prevent panics, the theories on which the legislation was based proved +untenable. + +Panics are not automatic. It was probably thought by many that they +were, and that they could be ended in automatic fashion. It is +impossible to foresee how a panic will arise. According to every +plausible theory, a panic should surely have been the immediate +consequence of the European War. Not only should a panic have arisen +then, but it should have been by far the worst panic this country has +ever faced. But no panic resulted, and all plausible theories have been +inoperative. + +Previous panics have been allayed by the actual suspension, or by the +potential suspension, of the Bank Act. That is to say, by the knowledge +that the Bank of England would have power to issue note currency to +any amount, unbacked by the deposit of gold. In other words, by the +knowledge that sufficient legal tender would be provided, _at a price_, +for the needs of all solvent people. + +The need, then, is currency--just as a person prostrated by fever needs +a tonic to restore him to convalescence. When the need is rightly met, +all is well. To withhold the remedy would feed the disease. Instead of +being checked, the disease would grow. + +Panic is a disease of the mind, and it most often proceeds, like +disease of the body, from excessive indulgence in a disease-producing +cause. It will suddenly arise as an offspring of wild gambling and +frenzied speculation, and it will infect people in a healthy condition +who fear they will be victims of the scourge. And it is not only the +duty of the State, but the highest wisdom of the State, to come to the +help of the healthy. + +We have seen how the State has performed this duty in the past, in the +days when banking was immature, and we have seen how it has performed +its duty, with perfect and instantaneous success, when the country +became involved in the greatest crisis it has ever faced. And this +is an experience from which, it seems to me, valuable lessons may be +learnt. + + + + +CHAPTER XII + +BANKING WEALTH + + +Having proceeded so far we may now be able to test, perhaps, with +more sureness the kind of wealth a bank does transform, and the kind +of wealth it should transform. On the character of the wealth sound +banking should depend. + +Wealth has degrees. There is the highest wealth and the lowest wealth, +with infinite degrees between. How are we to distinguish the highest +from the lowest wealth, to know the quality of that product which comes +into being from the satisfaction of desire? I think it is _time_ that +will enable us to judge. That is to say, wealth is to be judged by its +enduring qualities. The highest wealth is permanent, or lasting wealth; +the lowest is fleeting, or transient wealth. + +The most permanent wealth is food and air, because without this wealth +humanity would perish, and banking systems with it. But air cannot be +transformed, from reasons well known; but food can, and food satisfies +the most lasting of human desires. Only universal death can destroy +that desire. + +Let us examine with closer scrutiny the typical bank balance sheet +given in a former chapter. First of all comes gold. Now we regard gold +as the most permanent form of economic wealth. What alone gives it this +permanency is the law. It is not inherently permanent; inherently, it +is no more permanent than are diamonds or corals. We know that the +quantity of gold in the earth is limited, and that gold is perishable, +and that it cannot be got below certain depths, because men cannot live +beyond those depths. The time will come when gold will be exhausted, +and it will then be necessary to find another substance to perform the +functions allotted to it. As law has made it permanent wealth, so law +could to-morrow, by its arbitrary decree, make it impermanent wealth. +If gold were allowed to be, like diamonds, a mere commodity, then it +would come in a low degree of wealth. + +It is important, therefore, to be conscious of the arbitrary power +that makes this low degree of wealth permanent wealth. Because law has +decreed that it shall be in the highest class of wealth, then it comes +first amongst a bank’s assets, because this is the class of wealth that +in certain circumstances would have to satisfy the strongest of human +desires. Is it the wealth that a bank transforms? It is transformed, +because though it lies in a bank’s vaults, it is transformed into +the same substance as other wealth and thereby becomes fruitful. In +this manner it is able to multiply itself, not into gold, but into +other forms of wealth. It multiplies itself into gold indirectly by +stimulating and helping the production of it. When gold is brought to +the Bank of England and converted into notes, it performs the same +services as when it is taken to banks and is converted into that other +form of paper currency, cheques. The gold gets into circulation, and is +just as fruitful though it be circulated in the form of coin, instead +of notes. It makes no difference whether this gold is retained in the +vaults of the joint stock banks, or is placed in the keeping of the +Bank of England. In fact, if it is placed in the keeping of the Bank +of England, it can be made more fruitful, for the Bank of England +re-utilizes it, and increases the potential amount of currency based +upon it. + +The next asset is the money at call and short notice. The money at +call is, as already explained, practically the money lent to bill +brokers, and forms a part of what is called a bank’s liquid reserve. +If in a time of grave urgency the bank “calls” this money from the +bill brokers, it simultaneously “calls” in its loan deposits. It +is understood that in those moments the brokers would be unable to +repay their loans if they could not get the money from the banks. If, +therefore, they cannot get the money from the banks, how can this +portion of the deposits be withdrawable from the banks? If they were +withdrawn, they would have to be paid in again the moment they were +withdrawn. + +We know that in those times, however, the loans would be called and the +bill-brokers would have to borrow the money from the Bank of England. +And this money being paid over to the creditor bank, the deposits would +automatically fall, and the proportion of the gold reserve to the other +deposits would automatically rise. + +It is a conviction in Lombard Street that in those times the +bill-brokers could get no money from the joint stock banks. That being +so, what is called the credit superstructure does not appear to be so +unwieldy as it looks. + +The money at short notice presumably represents the money lent to the +Stock Exchange at settlement times. Those to whom the money is lent owe +the money to the bank, and when the bank asks for repayment the money +must be got elsewhere, and it can only be got from the Bank of England +on a certain class of security. Against these two classes of loans, +security is lodged with the lending bank. + +What class of wealth is this? The security for the money at call is of +a higher class than the security for the money at short notice. The +latter security consists of all kinds of Stock Exchange securities. +The most fleeting kind of wealth we may call the wealth brought into +existence by speculation. It is nevertheless wealth, for it satisfies a +desire and is exchanged. But as this desire is quickly destroyed, then +the wealth is either totally destroyed or partially destroyed with it. +Even war produces wealth, but as this wealth satisfies only a fleeting +desire its reproductive power is transient. It is like scattering +seed on the rocky ground, little of which is able to take deep root. +The harvest is scanty, and like all scanty harvests, it brings want +and ruin in its train. It lessens the reproductive and, therefore, +the consumptive power of labour, and thus directly affects harvests +elsewhere. + +Banks, therefore, in selecting the wealth constituted in Stock Exchange +securities must carefully discriminate between the lasting wealth and +the fleeting wealth; in other words, between high-class investment +securities and speculative stocks and shares. This, of course, calls +for intimate knowledge and sound judgment. These are qualifications +all bank managers must possess. If they possess the qualifications and +exercise the soundest judgment in selecting the highest type of wealth, +then they put into practice all the principles of sound banking. + +Now, there is no suspicion that these qualifications are not possessed +and that this sound, selective judgment is not shown by the managers of +our great banking institutions. This, therefore, is the basis of the +community’s confidence in them. That confidence is justified. + +We need not minutely examine the bank’s “investments.” Not only do +these constitute wealth of the highest class, but it is wealth not +represented by loans and immediate liabilities. They may justifiably +and safely be placed secondary only to the bank’s gold, forming a +portion of its liquid reserve. In the hour of danger or peril to the +community, it should be the duty of the Government, should the need +arise, immediately to transform this wealth into legal tender money. + +Bills discounted represent another form of the highest wealth of the +community, and the banks still adhere to the soundest principles in +discounting them. These bills represent that class of wealth that has +to satisfy the most enduring desires of the human race. Here, then, we +see the best judgment at work. There are, of course, many varieties +of bills of exchange. They may be placed in different classes, or +categories, according to their endorsements. What is called in the +market the “finest” bills are those endorsed by the leading banks, and +they are called clearing bank acceptances. Banks accept these bills +for small commissions, and they are more readily discounted then in +the market, simply because they have behind them the highest class of +wealth. Then there are bills accepted by merchants and other houses or +firms which are not of the standing of the clearing banks. They are of +an inferior category. The value of the acceptances and endorsements, +and therefore the value of the bills, depends greatly upon the standing +or reputation of the acceptors. + +Now the banks discount, as a rule, only the “finest” bills, that is, +the bills with the most reliable acceptances, bills accepted, say, +by other banks. In exercising this discrimination they exercise the +soundest judgment, and nothing higher can be expected of them. + +Such bills as these are readily discountable at the Bank of England, +and there is no sound reason why, in certain given circumstances, they +should not be discounted even by the Government through the agency of +the Bank of England. It might be in the interests of the country to do +this, especially as the machinery could immediately be set in motion. +And if the machinery could be set in motion immediately, then the bills +should be as good a reserve as legal tender. + +It is to be believed, too, that the soundest judgment is shown in the +selection of the composite wealth aggregated under loans and advances. +These represent the largest aggregate asset, but, at the same time, +they represent the greatest proportion of the loan-deposits, deposits +repayable to the bank. Such loans as these should be made of very short +duration, renewable, of course, but renewable for short periods. Is +it possible to make some kind of legal provision whereby in the event +of a remote disaster such as a panic these deposits, representing +liabilities to a bank, should be discriminated against and not be +withdrawable on demand? Could not the position be made clearer, as I +have hinted already, by segregating the deposit and current accounts? +Were this hint adopted the amended balance sheet would appear somewhat +as follows:-- + + _Dr._ + £ _s._ _d._ + Capital Authorized, £30,000,000 + Capital Issued 3,000,000 0 0 + Reserve Fund 1,125,000 0 0 + Current, Deposit and Other Accounts 8,908,141 17 8 + Loans on demand and on short notice due by + customers, as per contra 5,644,476 5 1 + Bills discounted, as per contra 6,811,870 13 8 + Loans and advances due by customers as per + contra 16,218,748 12 6 + Acceptances on behalf of customers 3,153,328 7 11 + Rebate of interest, etc. 53,807 1 3 + Profit 225,676 10 1 + ---------------------- + £45,141,049 8 2 + ====================== + + _Cr._ + + £ _s._ _d._ £ _s._ _d._ + + Cash in hand and at Bank of + England 5,996,667 14 8 + Money at call and short notice + as per contra 5,674,476 5 1 + ------------------ 11,671,143 19 9 + Investments 6,260,705 3 5 + Bills discounted as per contra 6,811,870 13 8 + Loans, advances, etc., as per contra 16,218,748 12 6 + Liabilities for Acceptances as per contra 3,153,328 7 8 + Freehold and leasehold premises 1,025,252 10 11 + ---------------------- + £45,141,049 8 2 + ====================== + +The answer might be that this would look too modest a balance sheet, +and would give less scope for boasting of the growth of deposits. +The deposits now look attenuated at less than £9,000,000, but look +at the cash reserve against them! Close on £6,000,000! True, this +cash melts at the Bank of England, but it gives the balance sheet a +truer and stronger appearance. If it be sincerely desired to give +greater enlightenment to the public, as many contend, then further +enlightenment can be given in this way, which is by no means the last +word in improving a balance sheet. + +But there is too much competition between banks; too deep a jealousy +and too keen a rivalry. This keen and jealous competition may be well +amongst merchants and tradesmen, but it seems neither healthy nor +dignified amongst banks. The work they do for the nation is too vital +for this kind of competition to be encouraged. Perhaps it would be in +the best interests of the nation if banks were nationalized, and made +branches of a National Bank. + +The main object of banks should not be that of the ordinary tradesman, +who boasts loudly and sometimes vulgarly of the trade he is doing. +There should be no incitement to this in banking, no incitement to +dilate composite deposits, to swell profits and to strain dividends. +With all this rivalry and incitement, this desire to gratify +shareholders, it is wonderful how cautiously and soundly managed +banks are. There should be no hesitation to perform their functions +within the limits of prudence, but, at the same time, there should +be no undignified display and boastfulness. This does not make the +deep impression some imagine. On the contrary, it tends to generate +the suspicion in many prudent minds that caution and safety are being +unduly strained. + +The public have not failed to notice that contrary policies have been +adopted by the great banks in dealing with their profits for the year +of crisis, 1914. Some reduced their dividends and others maintained +them. Some allowed liberally for depreciation, and others allowed for +no depreciation at all. Some provided for the future, others were +content to let the future take care of itself. And what conclusions can +the public draw from such divided counsels and irreconcilable policies? +Able to agree as they often are on common policy, they were unable to +agree on so important a policy as this. As one bank manager said to +the writer, when discussing this matter: “Even if the dividends were +earned, it was a matter of sound expediency in times such as these to +reduce them. It would have strengthened their positions and at the same +time have made a better impression on the public.” And there was much +wisdom in this view. + +Applying, as we have done, severe tests to bank management, it emerges +from them with great credit. Sound as the management is no bank +manager and no bank directors would be vain enough to claim that ideal +soundness has been attained. + + + + +CHAPTER XIII + +ELASTICITY OR INELASTICITY? + + +One of the great subjects of controversy, on which it seems impossible +to arrive at a common agreement, is whether the so-called loanable +fund is elastic or inelastic. It is admitted, I think, in a general +sense that in order best to help the trade of the country, it should be +elastic, that is, should be able to meet all the needs upon it. This +certainly should be the province of banking, and, what is more, it +should be the province of Governments to provide sufficient money to +meet the expansion of trade. It would be a foolish policy to shackle +and bind trade, to arrest its growth, by restricting facilities for +its growth. It would be like a foolish parent binding the limbs of his +child to stay their natural growth and to keep him a dwarf and a freak, +unable to do the work of a mature man. + +As the banking system practically performs the duties which in its +non-existence would have to be performed by a Government, then it +devolves upon this system to feed and succour commerce and to give it +every facility and every means for expansion. When I said in Chapter +XI that the transforming machinery should work with a pace equalling +the creation of wealth, it was tantamount to the view expressed by +others that the loanable fund of Lombard Street should be elastic. + +Instead of calling it a loanable fund, a vast pool of money into which +borrowers dip, a pool always filled by a perennial spring, I prefer to +call it machinery for transforming fixed wealth into mobile capital, +or currency. When I take my wealth to a bank I take it there because I +cannot use it fruitfully as capital in its fixed form. As I wish to use +it fruitfully the bank temporarily changes it into money for me, and in +this new shape I can make full use of it. + +Now, all who have practical experience of the banking system know there +are times when the banks refuse to perform this office for wealth +possessors. The machinery comes to a temporary stop. When we inquire +why it has stopped, we learn that it is because the proportion of +the reserve to the liabilities has fallen to too low a point. Others +would say, it is because the pool had been drained too far, was being +dried up, and that time must be given for money to flow in again. If +we liken it to a pool we find that instead of it having been drained, +it is really over-filled, and that what the banks desire to do is to +stop the overflow and to let the water sink. The banks say they have +lent too much, and must now lend no more for awhile; so they not only +stop lending, but call in loans, which again shows that the fund is +overflowing; it must be allowed to subside. + +We also see at times, when the fund is overflowing, that banks are +so eager to lend, that money is said to be a glut on the market and +exceedingly cheap. It is offered at nominal rates of interest. Why, +then, are there times when banks are eager to lend when the fund is +supposed to be overflowing, and times when, with an overflowing fund, +they refuse to lend? Why is it that at times when the fund is low they +are willing to lend, and why at other times when the fund is low they +are unwilling to lend? + +These phenomena prove, I think, that it is not a fund of money in the +real sense of the word. We can never tell merely by looking at the +aggregate deposits of the banks whether they are able to lend at any +given moment or not. We can easily delude ourselves by looking at the +bulk of that fund. What governs what we may call the transforming +capacity of banks is the quantity of gold they individually possess and +general financial and international conditions. In times of uncertainty +and apprehension, no matter from what circumstances or events these +arise, banks may refuse to lend, no matter what the condition of the +so-called loan fund may be. So far from lending when their deposits +appear to be very high, they are anxious to diminish these deposits and +gather in gold. + +It follows that the more gold they hoard the less becomes the loanable +fund. Therefore the more legal tender they accumulate at these times, +the less money they lend. Which seems anomalous and paradoxical. The +more money banks have at certain times the less they have. When the +hour of nervousness passes they begin to lend again. The money in the +shape of gold diminishes in proportionate quantity, therefore the +loanable fund of Lombard Street apparently increases as gold apparently +diminishes. + +This fund is, at times, like a spring in a desert. The thirsty +traveller sees it shimmering in the distance and hurries towards it in +profound gratitude, thankful that his thirst is to be slaked and his +sufferings are to be relieved at last. But just as he is about to put +his lips to the tempting waters, a voice of warning stops him. He is +not to drink, for the waters are too precious and must be preserved. +Not a drop can be spared. So he does not slake his thirst, and perhaps +afterwards succumbs to the torture he is suffering. + +The spring is there, but he is forbidden to drink! + +In the banks the source of money is there, but the gold must be +preserved, and the community must depart unsatisfied, no matter what +the consequences may be. The banks will not lend because they must keep +and increase, not their deposits, their so-called loanable fund, but +their gold. + +These deposits, then, are not strictly a loanable fund, otherwise the +more they grew the greater would be the fund. In fact, the fund would +be inexhaustible, increased and not diminished by the demands made +upon it. We know they are increased by loans. Therefore the best means +of increasing the fund would be by increasing the loans, and we could +then witness money actually piling up mountain-high in our midst. This +could put all fables of money-making by magic into the shade. + +Instead, however, of increasing the fund by lending as fast as physical +resources will permit, the banks adopt the contrary policy. They stop +making loans and simultaneously diminish the loans they have already +made. + +Whatever views the public may hold, bankers labour under no delusions +as to the real nature of the loan-fund. They know well enough they do +not lend out of that fund at all, for if they lent out of it they would +inordinately increase it by lending and so make more profit. It helps +to shed more light on the nature of the deposits. Why are banks anxious +to diminish the deposits in times of anxiety and apprehension? That +is to say, the loan deposits, and not the pure deposits? Why are they +anxious to diminish the aggregate of the so-called money fund? + +They wish to take away from their borrowers their power to withdraw, +even temporarily, gold. If they take this power from them the banks +know they will be in a far stronger position, even should the deposits +diminish by fifty per cent. In their own language bankers say: “We +must strengthen our cash position.” This means, then, that the cash +fund and the deposit fund are not one and the same thing. The cash +fund is strengthened by weakening the deposit fund. Cash grows as the +loanable fund falls. + +If the loan deposits are thereby greatly diminished until the deposits +are mainly what I have called pure deposits, it shows how the banks +safeguard themselves when they think danger is coming. Their assets +change. Gold takes the place of other wealth, and the banks are able +the better to meet a run on the part of their depositors. They have +automatically met the danger from the presence of the loan-deposits, +and now they have only to face the danger from the pure deposits. They +have fortified themselves for this by differentiating between the +characters of their deposits, which in their aggregate are misleadingly +called the loan fund of Lombard Street. The gold is the real lending +fund. + +This is done, too, often at a time most unfortunate for the general +community. It is done at a time when the community should receive more +and not less help from the banks. Banks ought to lend more freely in +times of crisis than at other times, for it is that freer lending that +will help the country to meet and get through the crisis. To stay help, +to withdraw help already given, is to increase the difficulties of the +general community, to feed alarm and apprehension, to aggravate the +crisis. The banks do, therefore, what seems wise, perhaps, for them, +but unwise for the community. + +They are not to be blamed so severely as some imagine. They have to +look to the law in the same way as the individual has to look at it, +and they cannot be blamed for acting in accordance with law. It is, +perhaps, the law that is unwise and not the banks. Communities must +abide by the laws they make, and by the limited freedom laws allow. +Laws are not the last word in human wisdom. Laws can be modified and +improved upon. + +Banks have to work within restrictions imposed upon them by the law, +and if these restrictions become harsh in times of difficulty and +crisis, then it is the law that is at fault and not the banks. + +Banks must pay out legal tender to their depositors on demand. The +Government restricts the supply of legal tender by enacting that +gold alone shall be legal tender. Therefore the Government is not +irresponsible for the manner in which the machinery works in all sorts +of conditions. + +If the supply of legal tender is restricted, no banking system, or any +system like it, would be possible if the reserves in legal tender had +to be equal, or nearly equal, to the deposits. If the banking system is +to be worked in the highest interests of the community, then the gold +reserves must necessarily be greatly less than the deposits. If the +people of this country took to hoarding gold, then the banking system +would eventually come to a stop, which shows again what the nature +of the loan fund is. There can be no loan fund without gold, and in +that case there could be no currency such as the cheque system of this +country. + +Ought we, then, to reform and modify the law? I can imagine the time +coming when legal tender will not be confined to gold. But this is +far distant. I think reform can come in the manner in which we have +experienced it since the war. The Government could ensure free working +in times of apprehension and crisis in the manner in which it ensured +it in August, 1914, by the creation of emergency currency. What can be +done successfully and beneficially once can be done again. + +If there are times and occasions when banks stop lending and when they +call in their loans, then it follows, reverting to market parlance, +that the loan-fund is inelastic. If it cannot always and invariably +respond to needs, then it cannot conform itself to varying conditions +and circumstances. This fact, therefore, supports the contentions of +those who say that the fund is inelastic. In my way I say the machinery +is far from perfect. It always works with difficulty at the very time +when it should work with ease. It will come to a dead stop at the +moment when it should be working at high pressure. + +To make the position clearer I will recall what Mr. A. C. Cole said in +his controversy with Mr. Tritton. + +“I entirely disagree,” he said, “as to the inelasticity of this fund. +My view is that the inelasticity is apparent, but not real. By this I +mean that it is inelastic at any given moment because, in these days +of competition, bankers lend all their available surpluses; but to say +that the short loan fund is permanently elastic is quite beside the +mark. What does inelasticity of the market mean? It means the want of +power of the market to adjust itself to pressure or tension. Now, take +the discount market. The supply of money always adjusts itself to the +demand. Except in times of panic, good bills are always discountable +in London. This Mr. Tritton practically admits in his paper. As +regards the large amounts of Treasury bills, Exchequer bonds, etc., +of which there has been a marked increase in recent years, owing to +the [Boer] war, Mr. Tritton says it is not very clear from what source +the funds so invested have arisen. This gives away his case, for it is +an admission that the money has been forthcoming. In other words, the +supply in the short-loan market has been increased because the demands +upon it have been larger, and this will always prove to be the case. +The short-loan market is really augmented quicker than any other fund. +It is quite immaterial whether the funds belong to owners in this +country or to capitalists abroad. The fact remains that the money is +available when wanted, or, in other words, the short-loan fund is so +elastic that it promptly adjusts itself to the demands upon it, though +temporary recourse to the Bank of England may be necessary, while +the adjustments take place. The apparent inelasticity of the fund is +evidence of what I may call the efficiency of the short-loan market. By +efficiency I mean that the total available funds in the market are in +constant use. This is not a bad thing for the community, but it implies +that on the least strain or dislocation of the machinery of the market, +recourse has to be made to what is then the only available source of +supply--the central institution. But as the Bank of England is always +willing to discount or lend upon good bills, the supply of money in the +market is never exhausted. It is simply a question (except in times +of panic, which we are not here considering) of the rate of interest +whether the money is forthcoming.” + +I cannot agree with Mr. Cole. If he admits that there is an exception, +and the exception works in a time of panic, at the very moment when it +is vital to the community that the exception should be removed, then he +gives away his case. He admits that the supply is not inexhaustible, +for it suddenly dries up when the need is greatest. To say that it is +“inelastic at any given moment,” that it is not permanently inelastic, +and that there are times when borrowers are driven to the Bank of +England, is inconsistent and illogical. If there are moments when it +is inelastic, then it cannot be permanently elastic. + +When soon after the present war complaints were made that banks were +not lending freely, and when a warning to them came from the Chancellor +of the Exchequer, it furnished further proof of inelasticity in times +of difficulty and pressure. + +Let us now examine further the machinery of the Bank of England and the +rate of interest. + + + + +CHAPTER XIV + +EXHAUSTIBILITY + + +If what is called the loanable fund were perfectly elastic and +“promptly adjusted itself to the demands upon it,” how is it that the +value of money, called the rate of interest, is not more uniform? It +certainly should be more uniform if it were a fund that automatically +responded to the demands upon it, increasing as the output of wealth +increased, decreasing when the output of wealth fell off. In a perfect +system this would certainly happen; but sound as banking may be within +its limitations, we must admit that it is far from being a system of +perfection. The fact that the rate of interest is not uniform, that it +rises and falls in a capricious and not uniform way, is further proof +that the fund is not, as it should be in a perfect or improved system, +elastic. + +Experience shows us clearly that as demand grows the potential supply +diminishes; therefore it cannot be a perennial, inexhaustible fund. If +bankers find that the demand is growing, they advance their rates of +interest. In other words, they demand a larger share of the profits +of the community. They have two objects to serve in this. They desire +to increase their own profits and they desire to check the demands +upon them. From their point of view, it is better to lend a little at +a high rate of interest than much at a low rate. In their annual or +semi-annual speeches bank chairmen are pleased if they can show their +shareholders that during a certain period the rate of interest has +been high; for it is evidence to them that circumstances have been +in their favour; that they have done good, profitable business. They +lament times when interest has ruled low. And interest rules low when +the fund is said to be overflowing, when the banks cannot lend as much +as they would like. There are, however, as I have already pointed out, +exceptions to this. It is no invariable rule, or law, or sequence, +whatever we may please to call it, that interest is low when the fund +is overflowing and high when the fund has fallen. Interest is governed +by many causes extraneous to the power of banks to lend, and these +causes often arise in an unforeseen, capricious way. + +We may say, however, while recognizing the effects of irregular, +uncertain causes, that the value of what is called bank money is +affected by the well-known law of supply and demand, the law that +affects the prices of commodities and of labour. In a general sense, +when the supply of money is greater than the demand the rate of +interest falls; when the demand is in excess of the supply the rate of +interest rises. + +Demand increases when borrowers multiply. Borrowers go in growing +numbers to the banks. As the loans thereby increase, so the deposits +increase. If, therefore, the deposits compose the loanable fund, the +loanable fund increases. At last, however, the loanable grows so large +that the banks say they can lend no more. Lend no more, when the +loanable fund is greater than ever? But the banker shakes his head. He +knows that though the loanable fund is greater than ever in appearance, +it is smaller than ever in fact. He knows that the greater the demands +made upon him the more his power of lending decreases, until the moment +arrives when he has to say “Stop!” He sees that as the fund rises the +proportion of the gold reserve falls. So he stops lending, lets his +loans run off, whether secured on bills of discount or securities, and +waits until that so-called loan-fund falls. And when it has fallen, +when the loan-fund is less, then he can lend again, although to the +uninitiated he has apparently less to lend. + +How, then, does this fund promptly respond to the demands upon it if +the supply of gold flowing into the banks does not keep pace with those +demands? If the supply of gold, not loan-deposits, kept pace with the +demands then, and then only, could the fund “promptly adjust itself to +the demands upon it.” + +It is elementary knowledge in Lombard Street that when the Bank of +England is able, week after week and month after month, to buy up all +the South African and other gold coming into the bullion market, that +it will tend to increase “credit” and depress loan-rates. We know that +the gold will increase the supply of market money more surely than the +growth in the country’s wealth. This is because we know the gold will +eventually find its way to the banks, increase their gold reserves, and +enable them to lend more. + +It proves, then, that the working of the fund, elastically or +otherwise, is dependent upon the flow of gold into the Bank of England. +This is because the law has decreed that gold shall be legal tender. +Therefore, the supply of money for the help of commerce, for the +fettered working of the banking system, is dependent in the ultimate +resort upon the law of the land. It is not dependent in the ultimate +resort upon the law of supply and demand, because a more powerful law +controls the economic law. If the law, then, controls the supply of +money, then the law must control the supply of wealth, and the law must +control ultimately the prices of labour and of commodities. + +When liquid capital is provided by the banks a charge is made for it. +This rate of interest not only affects the amount of capital that shall +be furnished, but it must affect the prices of the product that comes +into existence from the use of that capital. If the merchant has to +pay a high price for that capital, he must ask a higher price for his +product, for he will not use that capital unremuneratively. The greater +the abundance of capital employed in the country the greater is the +quantity of wealth produced, and the cheaper the capital the lower +are the prices of its products. That is to say, the greater are the +chances of the community partaking of a larger share of that wealth. +If they partake of this larger share it simultaneously increases the +collective, or aggregate, powers of consumption. + +It is indisputable that in times of trade activity the demands for +capital grow. Times of depression are coincident with a decline in the +demand. + +In this chapter I am but repeating much of what I have urged in former +chapters, but I am naturally anxious to make my argument as strong as +possible by the help of wider and, I trust, clearer illustrations as +I proceed. When we travel over a wide tract of country our vision is +too weak to take in all its topographical features. We can see general +features, but not the minute features which the botanist and the +geologist would examine. The poet would see what the geologist would +not see, and the botanist would see what would escape the naturalist. + +So when we take a survey of the economic and financial world we see a +mechanism which is not the same when examined minutely as when looked +at from a distance. When we look at it from afar we cannot see those +defects which on close examination we are able to find. + +If rates of interest arbitrarily rise and fall, and the supply of +capital is controlled in an arbitrary way, the general well-being of +the community must be affected. We suffer when the monopolist takes +advantage of the helplessness of the community to raise prices. We +suffer when shipowners take advantage of accidental circumstances to +raise freights and the price of food. We suffer when the colliery +proprietors in the depth of winter raise the price of coal. We suffer +also when the banks raise the rate of interest, thereby raising prices +and affecting employment. + +When prices rise, as they have almost uniformly risen in recent years, +many theories are advanced as to the causes of this. Some attribute +it to the increased output of gold. They mean by this that the output +of gold has increased so greatly that more money, or more purchasing +power, is placed in the hands of the community. Producers, observing +this, raise the prices of their commodities. If this were so, the +advance in prices would be general, and we should be no worse or better +off than when prices are low. Wages would inevitably advance if prices +were affected by this universal, not local cause. But it is asserted +that wages have not advanced uniformly, while tradesmen on their part +declare that their profits have fallen. Workmen and tradesmen alike +say that they are poorer than they were ten and twenty years ago, and +the housewife declares that a sovereign now will only go as far as +fifteen or ten shillings went years back. + +It is impossible to prove that such a rise is a consequence of an +accelerated production of gold. It is an hypothesis, and an hypothesis +it will remain, for it ignores a multitude of causes more important in +their aggregate effect than gold. + +It does not follow, then, that because at given moments capital may +be dearer than at other moments, a general rise or a general fall +in prices will immediately follow. Neither can we lay it down as an +indisputable axiom that a 5 per cent. interest, say, is detrimental to +trade, and a 2 per cent. interest is beneficial to trade. But we can +say, I think, that a very high rate of interest is harmful to trade, +particularly if it be prolonged, and that a constantly fluctuating rate +of interest is more unfavourable for trade than a uniform rate, or a +rate that varies but slightly. + +A high rate of interest means dearth of capital, and dearth of capital +must affect production and consumption and the output of wealth, just +as a dearth of seed must affect the coming harvest. The community, +therefore, must necessarily suffer from a dearth of capital, and as +the community is largely dependent upon the banks for the supply of +capital, then it follows that it is best for the community that the +supply should be constant, that it should adjust itself to the demands +upon it. If it could do this, then the rate of interest would tend +to greater uniformity. At any rate, it would not rise and fall so +capriciously as it does do. If it varied it would vary within narrower +compass. + +If this could be accomplished, if the supply of capital were less +dependent than it has been and still is, upon extraneous circumstances, +we may see steadier prices, and perhaps one happy effect would be less +labour difficulties and less strikes. Strikes are, in many instances, +the effect of constantly fluctuating prices. But the supply and +price of capital would not alone put an end to fluctuating prices. I +merely hint that it might help to correct those frequent and extreme +fluctuations that cause so much discontentment, and so much envy, and +so much misery. + +It would be interesting to speculate what would happen if the Germans +conquered us and took away our colonies and our goldfields. If Germany +restricted or cut off the supply of gold to this country, what would +happen to our loanable fund? How would it affect what we call the +creation of credit? How would it affect the supply of capital? If the +law remained as it is, and the banks could get no more gold reserves, +then there would be no loanable fund and no supply of capital. But the +law being what it is, the supply of capital is dependent upon the +supply of gold. + +Mr. Cole admits that on the _least_ strain, or dislocation of the +machinery of the market, recourse has to be made to what is then +the only available source of supply, the central institution, where +it is simply a question of the rate of interest whether the money +is forthcoming. After admitting, then, that the machinery can break +down and that then there can be but one source of supply, that supply +can only be obtained at a higher price. If it is to be obtained at a +higher price, then it is to be obtained at the general expense of the +community. If capitalists will not pay that higher price, then this +is tantamount to a lessened supply of money. As the Bank of England, +too, will not lend on the same class of wealth that the other banks +will lend on, a vast mass of wealth is excluded. Therefore a vast mass +of wealth cannot be transformed into liquid capital. If no one will +liquefy this wealth, then the production of liquid capital must be +limited, and that capital must remain in its fixed form till the other +banks restart their transforming machinery. If this be so, then the +supply even from the Bank of England is not, as Mr. Cole would have us +believe, unrestricted and illimitable. It is, after all, a restricted +supply, regardless of the entire claims or needs of the community, for +narrower discrimination is practised. The Bank of England may always be +willing to discount or lend upon good bills. But there are other bills +of a lower grade than this class of bill, and there is a vast quantity +of wealth that is rejected by the Bank. If the lending is limited to +good bills, and if the quantity of good bills is limited, then the +supply of money from the Bank must be limited. To say that the supply +is inexhaustible is, therefore, misleading. + +We know, too, from experience that when the Bank has been lending for +a time on good bills it has had at times to check these loans. And in +order to check them it has raised the Bank rate. Why has it raised +the rate? To replenish the supply that is said to be inexhaustible. +Mr. Cole says it could get that supply from abroad, and therefore the +fund would be replenished inexhaustibly. If, however, the supply from +abroad were checked, as we can imagine it could be, would the fund be +inexhaustible then? It would be interesting to know if, should the Bank +Act be suspended in certain circumstances, this would fall in with Mr. +Cole’s idea, or conception, of inexhaustibility. Also if the creation +of the Treasury notes falls in with that idea. + +We know, of course, that since the war the Bank has lent enormous sums +of money by discounting pre-moratorium bills of exchange. This may seem +to furnish proof of the inexhaustibility of the fund. But while it +has been lending it has been simultaneously receiving gold. There has +been no competition for the gold from South Africa and elsewhere, and +therefore the Bank has been able to procure it in the usual way. Then +New York has been obliged to liquidate its indebtedness to us in large +amounts of gold. But with all this, the proportion of the reserve has +kept well below the normal. What would have happened had the rebellion +spread in South Africa, and had the mines there been closed down +indefinitely? + +Even as it was, the Bank rate had to be maintained at an artificially +high level compared with loan and discount rates in the outside market. + + + + +CHAPTER XV + +THE THEORETIC LINE OF SAFETY + + +It will be clear, I think, from the analyses in the foregoing +chapters that banks have not only a delicate, but a most difficult +task to perform. So difficult is the task that it is impossible to +give satisfaction to all classes of the community. They have to give +satisfaction to borrowers, to their depositors, to their shareholders +and, at the same time, to the critics who say they are ever alert and +watchful that they are trading within safe limits. + +What critics mean when they talk of safe limits they would not find it +easy themselves to define with exactness. They know what they mean by +sound principles of banking so far as lending on sound security goes. +They know what they mean when they say that a bank must not engage +in speculation, and that it must carefully scrutinize every class of +wealth on which it lends. This seems to me a tacit acknowledgment that +banks do not create credit in the sense that many suppose. It would +come nearer the conception of credit creation if banks were allowed to +speculate and attempt to create wealth out of nothing. + +These critics lay it down as a first principle that a bank must have +adequate gold reserves. If they do not have adequate gold reserves +they put too great a strain upon the credit structure. But they cannot +agree, they cannot even dogmatize, as to what an adequate reserve +is. Yet the banks are adjured to give all the help they can to the +trade and commerce of the country. If they refuse that help they +come in for severe condemnation. They are condemned by the academic +critics and they are criticized by the traders and criticized by their +shareholders, and had not nature fortunately given bank managers very +thick skins--which thicken daily in the environment in which they +live--they would be deserving objects of commiseration. As it is, no +one pities them, and in time they become accustomed to an atmosphere +unwarmed by mercy. I have, indeed, met people who regard bank managers +as little removed from callous brutes, men utterly indifferent to +the appeals of those seeking to make their bit in a highly civilized +community. + +After all, the lot of a banker, like a policeman’s, is a hard one, and +he is very roughly handled at times by friend and foe alike: the friend +beseeching him to look to his reserves, the foe caring for nothing so +long as he can get his loan. + +Why does the friend beseech him always to have an adequate gold +reserve? Because the hour may come, suddenly, swiftly, without warning, +when the phlegmatic Britisher will be in the grip of madness. The man +who has calmly and resolutely faced the greatest crisis in his life; +the man who has laughed at Zeppelins and air craft, whose courage has +risen with his danger, is in a moment, in the twinkling of an eye, to +lose his reason and go amok amongst the banks of the country, smashing +everything in ungovernable fury. There will be no restraining him in +that mad hour. No force will be powerful enough to bind him. He will +wreck, and the populace will gaze on helplessly, until all are buried +beneath the ruins of a once beautiful and mighty fabric. + +It is because we fear this mad Samson will pull down the pillars, that +we would make those pillars too strong even for his mighty strength. +He would strain himself against them in vain. They would defy even the +supernatural strength of madness. + +It is feared that the reserves will not be large enough to meet an +outbreak of panic. As the banks are bound by law to repay deposits in +gold, or legal tender, if they have insufficient gold or legal tender, +they will come to smash. And if one great bank falls, all will fall. +The mighty structure will then be a heap of ruins. + +Let us, then, assume that some day, we know not when, it may be +to-morrow or it may be generations after we are dead and forgotten, a +panic _may_ come. It is said that the panic will surely be hastened +if the highly-strung, emotional, fear-stricken Briton _thinks_ the +gold reserve is falling too low. He may never know for certain whether +or not it is too low. But in some unfortunate moment, when, perhaps, +he is a little out of sorts, he may _think_ it is too low, and then +it will be too late. Without staying to reason, without staying even +to consider whether his disorder is physical or mental, or whether a +sluggish liver has blurred his vision, he is at the bank doors before +the maid has had time to bring in his breakfast. And when his mighty +fists smash at those doors the doom of the nation has come. + +What it is necessary to do, therefore, is to calm this nervous +gentleman; to talk confidently and assuringly to him, to talk about +politics, philosophy, poetry, the arts, anything but banking and bank +reserves, and then when he is smiling to take him out and give him a +good lunch. + +This is John Bull as some people picture him. It may be a caricature, +and John may resent it as a libel upon his traits and temperament, but +we must accept it as a serious fact that some people have no faith in +John Bull’s common sense. + +Regarding John, therefore, as a highly nervous old gentleman, who can +never rest because of that bank balance of his, wondering day and night +whether it is safe or not, and spoiling the peace of the household by +his restlessness, what we must try to do is to convince the old man +that his bank balance is perfectly safe. It may seem difficult to do +this when we tell him that the bank has only £15 left of his £100; but +it might be equally as difficult to set his mind at rest if we tell him +that the bank has only £40 of the £100, for he will want to know where +the other £60 is. Even £60 is more than John can afford to lose. + +Well, all that we wiseacres must do now is to have a little confab +together and agree upon the amount we shall tell him the bank actually +has intact of his £100. Perhaps we shall agree that £15 is much too +little. Perhaps to some £20 may appear to be insufficient. After +talking it over and diagnosing in the most up-to-date scientific +fashion John’s nervous temperament, we agree that his nervous system +can be made quite normal, as normal as our own, if we say the bank has +£30 of his £100, or nearly one-third. + +Thanks, then, to scientific calculation we have settled this problem. +John will be immune now from nervous disorders, he will be able to +sleep calmly o’ nights, and will settle down into a nice, comfortable, +affable old party, a perfect husband, and an indulgent parent, feeling +that nothing now is wanting in the best of all possible banking worlds. +Great mathematicians have assured him that the banks will never fail +now they have £30 of his £100 in solid gold. + +How agreeable it would be if we could settle this matter in a +scientific way, calculating with mathematical precision how much strain +the banking system will stand, and to a nicety what proportion of the +reserve to the liabilities will for ever avert a panic. Unfortunately, +mathematics will not help us in this. If we could only lay down a +theoretic line of safety, knowing precisely how far to go and where +to stop, how happy and contented we could be. The Philosopher’s Stone +could perform no greater miracle. The banks would then know exactly how +much to lend, exactly how much deposits to receive, irrespective of +gold production and wealth production, and the trade and commerce of +this country could be governed perfectly in true keeping with our needs +and the progress of civilization by that ideal law, rule-o’-thumb. +It would be impossible to imagine then to what heights of greatness +England would rise, or the reposeful content in which she would live. +As, however, scientific precision is impossible, we must rule out this +haphazard law. + +We must still trust as well as we can to experience. So far experience +has not failed us. This much can be said in its favour. + +It is impossible to say what proportion of reserve will save banks in a +possible panic. Perhaps eighty or ninety per cent, would not save them. +Perhaps they might go under with a thirty per cent. proportion, when a +thirty-one per cent. would have averted the disaster. Nor must we rule +out of consideration when contemplating the theoretic line of safety +the composite character of the deposits. + +Banks are counselled to adopt two extreme policies. That is to say, to +do the impossible. They are asked to lend freely to assist trade, and +at the same time are asked not to lend or to lend sparely. During the +early weeks of the war, for instance, they were urged to give liberal +assistance to commercial men and others, and at the same time to +increase their reserves and to be ultra-cautious. + +Some critics, and the most distinguished amongst them is Mr. Walter +Bagehot, urge them always to keep high reserves against the day of +panic, and yet when the panic comes to lend freely. They cannot lend +freely and simultaneously maintain high reserves. They cannot have +high and low reserves at one and the same time. They cannot lend +sparingly and cautiously in the same moment as they lend liberally and +incautiously. They must either keep high reserves and assist commerce +as sparingly as possible, or they must keep modest reserves and help +commerce as liberally as possible. They cannot adopt contrary policies. + +What should we say of the farmer who kept his seed in the barn and +feared to sow it to-day lest a storm should arise to-morrow and destroy +it? He must take his chances of a storm. And the country must take its +chances of a panic. + +But the chances are not so fearful as some imagine. Quite apart +from psychological considerations, there is the country itself, the +Government, behind the banking system. The country, the Government, +cannot afford to see that system come to ruin. It is not as if the +Government would be helpless. The Government has the power, and it +should use the power to prevent the ruin. Moreover, it is the duty of +the Government to prevent it. + +It is the Government’s duty because the Government does not allow free +banking in this country. This may seem a startling assertion. Let us +examine it. + +If the Government enacts that gold shall be legal tender, and that +banking deposits must be repaid on demand in their entirety in legal +tender, then banking is fettered by law. It is not free banking in +the full sense of the term. If banking is fettered by the capricious +output of gold, it is not free banking; and if the commerce of the +country is fettered by the capricious output of gold, then its freedom +of expansion is fettered. If the output of legal tender currency +cannot keep pace with the needs and requirements of commerce, then the +limitations imposed are not in accord with true notions of freedom. We +must work and progress as best we can within those limitations, whether +they be wise or unwise. + +Since the war the Government appears to me to have recognized this by +the issue of Treasury notes. Had these notes not been issued, then it +would have been the duty of the Government to have suspended the Bank +Act. Having issued these notes, the Government could conscientiously +ask the banks to assist in a time of crisis traders and others with the +utmost liberality. If they were not so assisted, the bankers justly +deserved admonition. But had the Government not have issued the notes +and therewith have provided legal tender currency in ample measure, +then it could not, conscientiously and justly, have bidden the banks +to lend freely irrespective of their gold reserves. If, however, these +reserves were to be replenished, then the banks were sufficiently +safeguarded. There was no excuse for ultra-caution and timidity then. + +I repeat, therefore, that what the Government has done once by way of +duty and by way of wisdom and foresight, it can do again, and should +do. The country must not come to ruin merely in deference to the +apprehensive theories of some people, whose theories so far, though +long and tenaciously held, have been like the passing nightmares of +affrighted men. + +In the days when Mr. Bagehot wrote his immortal work, banking was +still in the experimental stage. It was slowly developing and learning +from experience. As banking has developed, so has the psychology of +the British race changed. As the confines of its knowledge have been +enlarged, as each generation has arrived in a new environment, and +as each generation has become more familiar with and habituated to +banking, so are the probabilities of panic lessened. A panic, after +all, has a psychological origin, and if, as I contend, the psychology +of our race is on a higher plane, and is more dependable than it was +half a century ago, then Mr. Bagehot’s criticisms become less forcible +as psychological growth proceeds. They must not be taken, therefore, +as our criterion to-day, because the test applied to them now is a +different test. As the years go on the criticisms will become feebler, +and with his profound instinctive knowledge of human nature, I think, +were he alive to-day, Mr. Bagehot would modify those criticisms that +deserved more consideration in his days than in ours. He would be the +first to acknowledge, not only that the banking system has progressed +greatly, but that the system is conducted on safer lines than in the +times when he lived. + + + + +CHAPTER XVI + +SOME PSYCHOLOGICAL PHENOMENA + + +It has been said, and said truly, that the law can exercise much +restraint upon the freedom of the individual. It is powerless, however, +to restrain madness. Yet it is precisely by artificial methods that we +would attempt to restrain madness, to keep individuals and nations in +a state of sanity. This cannot be done. If the problem we are dealing +with is psychological, we must find a psychological solution. We cannot +cure a spiritual disease by a material remedy. If we can grasp the +potency of fear growing into that species of madness called panic, we +shall be able to grasp the tremendous task of allaying that fear during +its earliest symptoms. We should also grasp the immensity of the task +when we conceive how the healers of the disease would themselves be +afflicted by the disease, and that their fears would confuse their +minds and paralyse their actions. + +Long before the greatest war in history broke out, we were assured by +financial and economic prophets that when it did break out this country +would be in the throes of the most serious panic it has ever known, +and thousands of our business men would go down to ruin in it. These +prophecies were based upon the inadequacy of our gold reserves, and +upon the top-heaviness of our credit superstructure. + +These prophecies have not been fulfilled. We have had no panic, not +even when the Bank of England reserve fell to the lowest point for +many a year, not even when the rate rose swiftly to ten per cent. +Thousands of our great business men have not been ruined. These are +facts, not theories. They are realizations, not predictions. So far +from there having been a panic, it has been very difficult at times, +as all acute observers will testify, to realize that this country was +at last engaged in a life and death struggle. It was prophesied, too, +and with no doubts or hesitation, that the numbers of men thrown out +of employment would be so great, that drastic martial law would have +to be resorted to. These predictions also have not been justified. +The percentage of employment has steadily risen, and this nation has +pursued its affairs and avocations calmly under normal police law. + +If we are to learn deep and lasting lessons from experience, this +experience is of vastly greater value than theory. In Germany and in +France also we see vast accumulations of gold, in comparison with which +our own gold reserves are puny. Yet we not only raised immense war +loans at a high price, but have helped other countries with loans, +while our burdens were increased with the heavier taxes imposed upon us. + +True it is that but for our navy, circumstances might have been greatly +different. But had our navy been sunk, had Germany acquired undisputed +mastery of the sea, had she been able to starve us, then no gold +reserves, even though mountains high, would have saved us. The country +could not live on gold alone. It would have perished, and its banking +system with it. We cannot wage a life and death struggle with gold +alone, nor with credit alone. + +But when the former prophecies were made, no account was made of the +navy. The panic was to come independently of the navy’s power. The +public, the moment war was declared, would realize that the gold +reserves were inadequate, they would clamour for gold, the banks would +close, and in a day or two the money market would be a deserted, silent +place, stricken and devastated like some of the cities of Belgium. + +Why did not this come to pass? Why were the prophets not trusty seers? +It is said that the bankers met in conference to consider and exchange +opinions upon the position. They knew well enough that they were no +magicians, nor even ordinary conjurors. They knew they could not +make gold out of nothing. What, then, could they do? Whether or not +their consciences smote them I know not. Whether or not they bitterly +repented and lamented the poverty of their gold reserves I know not. +Whether or not they said to each other, in a hopeless, perplexed way: +“I told you so,” I know not. All I do know is that a saviour came, a +_deux ex machina_, that he was received with open arms, welcomed with +fervid gratitude, perhaps with tears, that he was venerated, and that +some to-day, in their profound gratitude, would make him a duke. + +Well, this saviour came and calmed that assembly; in a magical way, +subdued all fear, removed all perplexities, daring to do, so some say, +what some bankers themselves dared not even hint. Greatness of mind +saved them and the nation and not the greatness of our gold reserves, +and this greatness of mind has been acknowledged by all, not with +the reluctance of envy, but in the spirit of sincere thankfulness. +Greatness of mind, then, saved the nation from the consequences of that +psychological evil, fear and madness. It was the right mental solution +to a mental disease. The spirit saved the spirit. + +So it has been throughout the ages. Greatness of mind has led nations +on. Littleness of mind has brought them down. And who will deny that it +is littleness of mind that has brought Germany down? A nation derives +its greatness from the greatness of its greatest souls. + +The nation was saved, then, in the hour of destiny by obedience to +wisdom. We cannot imagine in the future a vaster crisis than the +nation--yea, the world--faced in that dark hour in August. It was +not alone the magnitude of it, it was the suddenness of it. We were +unprepared for it, and if wisdom could save us in this hour, what can +we hope from wisdom in the hour of less peril? + +Had wisdom not prevailed, had we abandoned ourselves to divided +counsels and to folly, we might not have saved ourselves from the +consequences had our gold reserves been much higher. They might quickly +have disappeared. Theoretic lines of safety would not then have averted +the wreck. They would not, with magic power, have kept the public back. + +In that hour some would have cried hysterically: “Lend, lend, lend!” +Others, “Save, save, save!” and only confusion and perplexity would +come of it. But the public were told, by the representative of the +Government, by the authoritative voice of the nation itself: “Be calm! +All your wants will be supplied! The Government will supply them.” + +When a hungry multitude is clamouring for food, mad with hunger, and +when the barns are filled, they are not appeased if told there is only +sufficient food for a few. Tell them there is enough food to go round, +even though it must be given sparingly, then the clamour dies down and +the multitude becomes calm and patient. + +We saw no multitude clamouring for gold. The clamour was merely +anticipated. There may have been no clamour, but it was wise to +anticipate and prepare for its possibility. At the right moment, +therefore, the public were assured that money, not gold, would be +forthcoming in any amount. It was money, not gold, that allayed the +first symptoms of fear. With this money, no matter though it were +paper, the public were content. The notes were instruments of law that +placed them in an impregnable position, and in an impregnable position +they knew they were safe. + +The faith the public put in gold is probably greatly magnified. The +public are not deeply versed enough in monetary and currency problems +to understand the importance of gold as distinct from other money, +especially legal tender paper. The ordinary man in possession of twenty +£5 notes feels that he is equally as safe and as strong as the man in +possession of one hundred sovereigns. We must not ignore this fact, +nor minimize it, when we argue about high and low gold reserves. He +knows that with notes he can be just as solvent as the man with gold, +though he may think the notes a greater nuisance than gold. And this +belief and trust of his, this calmness, are all essential elements of +the psychological problem that confronts the currency theorist and the +banker. They are not to be considered as mental phenomena independent +of that problem. They go to make up its complexity. + +London being a free market for gold it was feared in a crisis such as +we have experienced, that the gold would quickly be withdrawn from the +Bank of England and shipped abroad, and that in a short time we should +find ourselves with no gold reserves. This did not happen. Granted +that a great deal of gold was withdrawn from the Bank, this was only +temporary, and since those days the Bank has secured gold at a pace no +prophet ever calculated. Two predictions here have also been falsified. +Neither the gold withdrawals, nor the gold arrivals and accumulations +were on a scale forecasted by the theorist. Their pre-calculations went +ludicrously astray. + + + + +CHAPTER XVII + +EQUITABLE RESPONSIBILITY + + +If gold reserves alone are to be the test of sound banking, and if +gold reserves alone are to save banks in the hour of crisis or panic, +then the obligations of banks towards the highest interests of the +community are weakened. If their wealth, their investments are to be +valueless in a time of crisis, to be so ignored, that is, as to be +worthless, to be taken no account of, are not to keep them solvent and +safe, then on what grounds of reason and justice should the community +demand that banks should confine their trading to the highest class of +wealth? On what grounds can the community demand that they should in +all seasons and in all times do that great work for trade and commerce +which neither the Government nor any other institution does? Why should +the banks be asked to do all the sacrificing within the limitations +imposed by the community and the community not come to their help, +sacrifice nothing at all, in the hour of the community’s troubles? +For the crisis, when it comes, is the nation’s and not solely the +banks’ crisis. If the crisis be none of the nation’s seeking, it will +certainly be none of the banks’ seeking. If, however, the crisis be the +effect of over-speculation on the part of the community, it would be +mean action on the part of the community to appeal to the banks to save +it from the consequences of its own folly. + +I urge that, in a time of national crisis, which has taken the +nation by surprise, which is no consequence of its own folly, the +responsibility should be shared by the nation and the banks. It is +possible that it was this high sense of justice, this high sense of +equity, that inspired the measures that were taken last August, and +that brought the country safely through the crisis. Had it not been for +this higher inspiration and deeper vision, and had we trusted alone to +narrow instinct and lack of insight, confusion might have reigned, and +the consequences might have been as serious as those foretold by the +prophets. + +If we are to lay it down as a rigid, unwritten law, a law existing +only in the conscience of an irresponsible community, that banks must +save themselves only by their gold reserves, then by what divine +or earthly sense of justice shall we demand that banks shall not +speculate? Are the banks to be the keepers of our consciences, as well +as of our purses? The banks must live. And if instead of building up +their deposits on sound wealth, they build them up on unsound wealth, +and keep that proportion of reserves which critics demand they shall +keep, then they will have fulfilled their duty from the standpoint of +this narrow conception. Suppose they speculated and kept even higher +reserves than those laid down by the mathematicians, content with the +higher profits made from speculation, by whose standards of equity are +they to be judged? + +If high gold reserves alone can save them, or should save them, and +they possess these high reserves, then they can be saved even if they +speculated. If the oracles say so, it must be so. If sound wealth be +useless to them, then unsound wealth could not be more useless. If they +could not get legal tender for sound wealth, for gilt-edged securities, +they would be no worse off with brass-edged securities. + +As I have already insisted, it is something beyond lack of reason +to ask banks in the same moment to lend freely and to save their +gold reserves. It is as unreasonable as asking an ordinary man to be +generous and prodigal and at the same time close-fisted and thrifty. + +Take that measure of the Government whereby it arranged with the Bank +of England to discount, without recourse to the holder, all approved +bills accepted before the declaration of the moratorium, guaranteeing +the Bank against any loss it might incur. This was, of course, placing +a burden on the shoulders of the community which was a perfectly +equitable burden. But quite apart from its equity, it was, in its +lowest aspect, an expedient burden. That is to say, if the nation had +refused to shoulder this burden, it would have had a far greater burden +to bear in the dislocation of trade and its incalculable losses. + +It would not have been just to place this burden entirely on the +shoulders of the banks. In such a crisis the entire community had to +face the perils as a whole, and sink or swim as a whole. + +When in the end the gains and losses are weighed, perhaps we shall find +that the gains, moral and material, greatly outweigh the losses. + +What was the duty of the banks, when this measure was proclaimed, +towards the nation and towards themselves? Looking at it from the low +standpoint of self-preservation, what was their duty? From a low and a +high standpoint alike it was their duty to help the Government, help +the nation, through the Bank of England. They could not give that +effective help by hoarding their gold, by getting it from the Bank of +England, by sending borrowers to the Bank of England, by refusing help +to legitimate needs. Yet this is what some critics counselled them to +do--counselled them to increase and not ease the difficulties of the +Bank of England. + +If the country could depend calmly and securely on the Bank of England, +with the Government behind it, then the banks also could depend upon +it. The Bank of England was the bulwark of England. That bulwark +could be weakened and not strengthened by the hoarding of gold. If the +Press and others admonished, and wisely admonished, the citizens not +to hoard gold, then it was illogical to ask the banks to hoard it, for +they would be hoarding the citizens’ gold. These contrary counsels were +opposed to all reason, and yet to this hour I see them advocated in +some quarters in the Press. + +The Bank of England needed all the gold it could get as a basis +for the discounting of this huge mass of pre-moratorium paper. +Gold subsequently poured in from the gold mines and elsewhere, yet +notwithstanding this mighty inflow, the proportion of the Bank’s +reserve to the ever-growing deposits kept comparatively low, far below +the normal proportion. It was in the interests of the country that +the Bank should get this gold from any quarters to enable it to make +a success of the remedial measure and to ease the country’s financial +burdens. How, then, could it at the same time be in the interests of +the nation for the joint stock banks to take gold from the Bank, to +hoard it and not to send it there? + +Such action as this would have been inconsistent with the fervent +gratitude the bank chairmen and the country have felt towards the +Government and its advisers. + +Furthermore, what made it additionally ill-advised on the part of the +banks to hoard gold and pile up their reserves, was the subsequent +proclamation by the Government to the effect that the Bank of England, +on the authority of the Government, would advance the necessary funds +to meet acceptances for which cover was not duly forthcoming from +clients, until one year after the close of the war. This removed all +necessity to hoard gold and to pile up reserves, and it justified the +rebuke of the Chancellor of the Exchequer to those banks that refused +necessary accommodation to legitimate business. It was also a rebuke +to those critics who have seen no refuge for the country in the dark +hour of trouble except in hoarding by the banks and parting by the +public. That is to say, they counsel the public not to demand gold, and +they counsel the banks to keep it. If, therefore, the public are not +to demand gold, and if the banks are to accumulate it in their vaults, +then it means that in a crisis we can do without gold, and that, after +all, the credit which the banks are said to create will alone save us. +They are told that if they will only go on creating this credit they +will enable us to pass safely through the crisis. It comes to this, +that the advice given places us in mental confusion. Actual experience, +therefore, seems to be trustier than illogical advice. + +What has been the direct consequence of this discounting of +pre-moratorium bills and this great inflow of gold, despite the issue +of a War Loan to the prodigious amount of £350,000,000? In the words +of the money article, day by day and week by week, money has been a +glut on the market, and has been lent on nominal terms, while discount +rates have also fallen to nominal quotations. In other words, the +great joint stock banks, in spite of themselves, have seen their gold +reserves rising to an unprecedented extent. Of what benefit to the +country is this great mass of idle gold? It is unproductive. It serves +no useful purpose if it cannot be employed. It is like the grain in the +barns perishing because it cannot be consumed. Yet in spite of this +state of things, due to the supply of liquid capital exceeding the +output of wealth, there have been those who have lamented the fall in +discount rates lest this should turn the exchanges against us, and gold +should be taken to New York or elsewhere. Would it not be beneficial if +some of the gold did go? If it went in payment of wealth received, the +gold would then become productive. The right service of gold is to help +to produce wealth, and if it does this it performs the services deputed +to it by the community. When gold passes from one nation to another +in exchange for wealth it never passes permanently. I might just as +reasonably urge that when I pay gold to my tailor for my dress suit I +part with the gold for ever. I should part with it only in the event of +my immediate decease, or if I became a non-producer, or in other ways +were deprived of all claims on the general wealth of the community. An +idle man, with pockets filled with gold, is a burden on the community. +He is no helper, no benefactor. So a nation, idle, with mighty safes +filled with gold, will become stagnant if this gold is not scattered +broadcast in the shape of capital that energizes the productive and +consumptive capacity of man and the land. + +The value of gold will ever inhere in its wise use, not in its non-use. + +“It has been well said,” remarked Sir Felix Schuster, in his recent +annual address, “that it is one of the paradoxes of finance, that at +the moment when the world’s capital is being squandered in war the +value of loanable capital in Lombard Street has actually depreciated.” +Sir Felix meant, of course, that there was no great demand for capital, +that it was greatly in excess of needs, that loans consequently were +cheap, and that banks could hardly lend profitably. I see no paradox in +this. If the creation of bank money is to be regulated by the supply +of gold only, it is an orthodox consequence. Since the outbreak of +the war the inflow of gold has been greater than ever experienced. +This has given the banks power to lend more, to liquefy more wealth, +because their reserves have increased, and the proportion of these to +the liabilities has correspondingly risen. But though a great deal of +wealth has come into existence, it must not be overlooked that a great +portion of it is not the kind of wealth banks lend on. This was partly +due to the closing of the Stock Exchange, the subsequent restrictions +on business there, and the destruction of trade between the belligerent +and other countries. Securities of a high class were scarce, and +bills of exchange became scarce, and while many industries, notably +the cotton industry, severely suffered, other industries, especially +war-provisioning industries, became abnormally busy. There was deadlock +for months in some of the foreign exchanges, especially the New York +and Russian exchanges. While the kind of wealth on which banks lend +fell off, the mines continued to produce gold, thus showing again how +independent this output is of real wealth production. Had the gold +mines also ceased working at the beginning of the war, have suspended +operations for many months, we should not have seen, perhaps, loanable +capital in Lombard Street so excessive and so depreciated as it was. + +Sir Felix saw a great danger in this great mass of money and its +cheapness: the danger of its turning the exchanges against us. But this +danger could have done no more harm than the stoppage of the gold mines +had the rebellion spread in South Africa. The danger can be easily +exaggerated, especially at a moment when we can see far ahead, and see +the gold still coming to us in an uninterrupted stream from the mines. + +Even had the New York exchange turned against us, it would turn round +again in due course, as it always has done and always will do so long +as international commerce proceeds. + +By no jugglery can we, in the existing system, make cheap money +dear, any more than we can make cheap apples dear. It can be done by +cornering; but no cornering of money is possible. If banks cannot lend +at 1 per cent., they certainly cannot lend at 2 per cent. Human nature +must be re-created first. If men will not part with bills of discount +at 1½ per cent., they will not part with them at 1¾ per cent., and +there is no law, written or unwritten, that will compel them to do +this. The law of supply and demand operates as irresistibly in this +case as when we buy apples at an old lady’s stall. + +If there be great danger in a great abundance and cheapness of money, +then there must be a great danger in an abundance of gold, which is +the source of the cheap money. Logic teaches us this. Reduce the gold, +hoard it or throw it in the ocean, then the supply of Lombard Street +money will decrease and loanable rates will rise. + + + + +CHAPTER XVIII + +CORRELATION + + +It may now pertinently be asked: Is it possible to keep high gold +reserves in the joint stock banks, taking them as a unit, and +simultaneously a high reserve in the Bank of England? By high reserves +I mean, of course, a high proportion, for this is what we all mean. +What is the test of a high reserve? There is no other test than the +ratio of the gold reserve to the liabilities. We cannot test it by a +quantity of gold _per se_. We cannot say that a hypothetical quantity +is sufficient and a hypothetical quantity insufficient. A reserve +must be related to something. When we speak of gold reserves we speak +correlatively. They are not something standing apart, in the air, as it +were, an independent quantity. + +If, then, when we speak of gold reserves, we are conscious of their +relation to something, what is this something? Is it their relation to +the nation’s commerce as a whole, the nation’s needs as a whole, or +merely the restricted relationship to bank liabilities? What critics +mean is the relation between them and the bank liabilities. But banks +are units of a system. They are not a whole in the same sense as the +Bank of England is. They are independent entities. There are large +banks and small banks and medium-sized banks, and they have liabilities +corresponding to their size. Must the small bank have in its safes +exactly the same _quantity_ of gold as the large bank, irrespective of +its liabilities? Or must the small bank have, not the same quantity, +but the same _proportion_? Or are we to aggregate all the liabilities +of the banks of the kingdom and all their gold reserves and say whether +or not the total quantity of gold is sufficient or insufficient? Even +then we must ask: Sufficient for what? Sufficient to meet the total +liabilities in a time of crisis? This is what we mean. We mean a ratio, +a hypothetical ratio that is to save us from disaster. + +Now this ratio is constantly fluctuating. It is fluctuating hour by +hour, day by day, week by week, month by month, and year by year. It +is impossible to keep it rigid. The critics know this, and they say +that only an approximate ratio is wanted. But as we can never foretell, +never pre-calculate what an approximate crisis will be, an approximate +panic, or an approximate run, an approximate ratio may not save us. If +mathematics alone will save us, and not common sense, then we must have +mathematical precision, seeing that we are dealing with figures, not +brains and temperaments. + +The only way to keep up an approximate ratio is, not to buy gold, as +many advocate, and hoard it, but to stop lending, to call in loans, +and so raise the ratio figure. Then we can have a relative high gold +reserve. We are speaking, of course, in an ideal sense, for there can +be no simultaneous precision in these movements amongst a number of +independent banks, whose business varies hour by hour. + +However, in order to maintain their high ratio banks must cease to +lend when this ratio threatens to fall. It is useless buying several +millions worth of gold--if it could be bought--only to lend more upon +it, increase the liabilities and not alter the habitual proportion. + +If, therefore, banks cease to lend in order to keep up a high ratio of +reserves to liabilities, what will be the inevitable effect of this +upon the reserve of the Bank of England? They will drive borrowers, as +has been explained in former chapters, to the Bank. As the Bank begins +to lend, so will the ratio of its reserve to its liabilities drop. Mr. +Cole says the Bank of England will always lend _at a price_. If, then, +the Bank’s ratio drops, then the ratio of the reserves of the joint +stock banks must fall, seeing that they hold their reserves at the Bank +of England. The ratio will then drop in proportion to the aggregate +bank liabilities of the kingdom. + +The only remedy, then, is for the Bank of England also to refuse to +lend. But Mr. Bagehot and other critics say this would bring on and +aggravate a crisis. So far from refusing to lend, banks, they say, must +lend liberally, with both hands. How, then, are the Bank of England and +the other banks to lend liberally without increasing their liabilities +and reducing the proportion? The proportion could be maintained only by +an inflow of gold proportionate to the rise in the liabilities. How are +we to start this inflow at the critical moment and maintain it? + +It cannot be done. There can, however, be an automatic inflow, but only +of legal tender notes, and legal tender, from the standpoint of bank +solvency, is as potent as gold. We cannot produce gold at will, but we +can produce paper at will. + +Our gold reserves should be controlled, as I have insisted already, +not solely by the arbitrary output of gold, but by the output of the +nation’s wealth, and by the nation’s needs, and no artificial obstacles +should arrest the growth of national wealth. We do put obstacles in the +way. Banks must keep an eye on their approximate reserves. This is why +they refuse to lend at times, and send wealth-producers to the Bank of +England. We have to put up with this in our present system. But to say +that some hypothetical ratio, which no one can agree upon, will save us +in certain grave, incalculable contingencies is as untenable as many +another economic hypothesis which has no relation to the complexity of +human character and temperament. + +But the theorists have insisted in years past, it is not the national +needs we have to consider in a time of crisis; it is the international +claims upon us. Look, they say, at the enormous foreign credits here, +placing unlimited power in the hands of foreigners to take gold from +us _in the time of war_. Well, the war has come, the greatest of all +wars, the war we and the world most dreaded, and all these pre-existing +fears have not been realized. Foreign credits are offset by foreign +liabilities here. Instead of gold being taken abroad in great quantity +the exact opposite has occurred, and why should it never recur? +Gold has come to London in quantities never dreamed of and never +experienced, proving that the dimensions of this hypothetical danger +were greatly magnified. + +Since the war we have had too much gold and too much capital, even at a +time when unemployment was low. I mean too much bank capital. + +It follows that, as conditions of banking are at present, we cannot +have high proportionate gold reserves in the joint stock banks +simultaneously with a high proportionate reserve in the Bank of +England. This can only be done by stopping the wheels of commerce, +or slowing them down by advances of the Bank of England rate to +attract gold from abroad. But the gold must flow in as rapidly as the +liabilities rise, unless the Bank of England stops lending too. Trade +must be penalized whichever action be taken, and merchants and others +would rather have low ratios than be penalized. They would suffer, and +the country would share their sufferings. To refuse to lend would have +serious consequences and would be the surest way to hasten a panic. + + + + +CHAPTER XIX + +THE SUPPLEMENTARY INFLOW + + +If there must be in the country, for the benefit of the country’s +trade and commerce, for ensuring its prosperity, a loanable fund, why +should no provision be made for what I call the supplementary inflow? +If no provision of this kind is made by a nation, how can we reconcile +this with national foresight? In carrying on business on the soundest +principles of finance business concerns allow amply for contingencies +by building up reserve funds. If this be sound in individual business, +it should be sound in national business. We cannot logically have +contrary business principles for the nation and the individual, for in +that direction confusion lies. + +The nation trades on its capital. It is a vast undertaking, with a +colossal capital. It incurs huge liabilities, but against them it has +huge assets. Why should it not have amongst these assets large hidden +reserves? + +Some wealth depreciates, while other wealth appreciates. Some wealth is +destroyed, while new wealth is created. Wealth is not destroyed by war +alone. It is destroyed by new desires, new inventions--which destroy +the wealth brought into existence by former inventions and bring ruin +on some industries and men,--new fashions, and by lack of hope and +diminishing confidence. On the Stock Exchange in recent years we have +seen continual depreciation. But other assets may at the same time have +greatly appreciated. + +We cannot get more gold than nature will produce, and every ounce taken +from her store lessens that store. And the store will diminish as the +future needs of the world grow. + +The gathering of the gold and the garnering of it, like the garnering +of seed we fear to sow, must be done at the expense of our wealth +production. The harvest of wealth must be less because of the scantier +seed sowing; in other words, because of the diminished capital +employed. Instead, therefore, of the gold coming out of the nation’s +profits, it would come out of the nation’s capital, for unused capital +is not used capital. + +Gold is our capital in a fundamental sense. If all the gold in the +world were suddenly destroyed, banks would cease to exist. Whence, +then, could we get the means of multiplying our capital? The productive +machinery of the country would become inert. International trading +would cease, because international exchange would cease. Bills of +exchange would be as worthless as old newspapers, for they would be +unnegotiable. We should have to get a substitute for gold. + +We try to attract gold to this country because it is gold that keeps +the capital-multiplying machinery going, as oil keeps other machinery +going. If we always had a sufficiency of it there would be no occasion +for high Bank of England rates. If there be just a sufficiency and no +more, then we cannot spare any for hoarding purposes. + +It would be wise of the nation to have at its command a potential +supplementary supply, not of gold, but of legal tender, for legal +tender can perform all the offices of gold as national currency. Gold +is given its potency because it is made legal tender. It has no other +vital potency. Therefore paper, or any other substance, can be given +equal potency by law. + +Now, the necessity of having this supplementary supply has been tacitly +acknowledged. The acknowledgment is implied in the provisions of the +Bank Charter Act and the provision of legal tender notes based on +debt and securities. This provision, as I have pointed out already, +is arbitrary. It was fixed at a time when no man had the visionary +power to foresee and forecast the great development of banking in this +country and the vast development of its national and international +trade. It was fixed at a time when the country was groping towards +a greatly improved currency system, a system that has helped in an +incalculable degree the growth and development of our commerce. + +But in the recent crisis it was not this potential supply that the +nation actually tapped. Before it could be tapped it was necessary to +suspend the Bank Charter Act. Instead of this happening, a new and +unlooked-for supply was forthcoming in the shape of the Treasury notes. + +This issue of Treasury notes brought a new fiduciary currency into +existence, and the issue was on all fours with a free Government +loan--a loan, that is to say, on which no interest was paid. It +provided not only currency for the country, but “silver war-bullets” +for the Government. The issue performed all the essential services +which the supplementary fund I advocate should and would perform. + +I am convinced that the alarm felt throughout the country in +those first critical days was magnified. There was certainly some +apprehension; but no good purpose would be served by magnifying it. It +is indisputable, too, that even this moderate apprehension disappeared +the moment it was known that a large amount of legal tender would be +issued in the shape of £1 and 10_s._ Treasury notes. + +The notes were based on what we call the credit, or wealth, of the +country. The public placed their confidence in them because they felt +they were placing confidence in the wealth and power of the country, in +themselves as a nation. They could have no sounder basis. The nation +was indifferent to the convertibility or inconvertibility of the notes. +All the country was conscious of was that the notes were legal tender +and as good as gold. + +Theorists attach too much importance to the effect upon the public mind +of an issue of inconvertible notes. The great mass of people does not +understand convertibility or inconvertibility, certainly not in the +deep sense critics imagine it does. It understands, however, confidence +in the Government, and this confidence is of greater worth than are +vague ideas of convertibility. The mass of the public is ignorant of +monetary and currency problems, but it is not ignorant of the power +of the Government and the power of the law. When the mass of the +public had these notes--and even postal orders as legal tender--in its +possession, it knew it had purchasing power equal to the denomination +of the notes, and that was all-sufficient. This explains the public’s +satisfaction and calmness. Moreover, it is a phenomenon of deep +psychological importance. + +There were sections of the public--merchants, financiers, bankers, +academicians, theorists, and pressmen--who knew that the notes, though +issued as convertible, had behind them no gold backing. But even many +of these were not erudite students of currency. Nevertheless, they +could not help feeling and acknowledging that the right and wise +thing had been done. And as for merchants, bill-brokers, bankers, +and other people who wanted legal tender currency, they cared not +so long as they could get it. This was their chief concern. It was a +matter of indifference to them whether the notes were convertible or +inconvertible. + +Perhaps the most fruitful point for controversy at this juncture, now +that we have experienced the benefits of the policy, is whether it +would have been better to have suspended the Bank Act and have issued +Bank of England notes, or to have done what actually was done. Much can +be urged in support of each policy. Bank of England notes would have +obviated any confusion arising from two distinct species of fiduciary +paper currency. + +The great virtue and convenience of the new notes was their low +denomination. It would have created needless difficulties, perhaps, to +have given power to the Bank of England to issue such notes. Confusion, +therefore, was greatly lessened by making the Treasury notes of low +denomination and by keeping the Bank of England notes at a high +denomination. As a fiduciary note, currency should be as simple as +possible and not complicated, the distinction between the denominations +should conform to the idea of simplicity. + +I think it would be wise to teach the people that the currency of the +country is in reality based upon the wealth of the country, and not +upon an extraneous thing like the capricious production of gold. This +would assist it to grasp more easily currency problems. What would +be the state of this country with a mountain of gold and no wealth? +Currency being issued on a basis of wealth, it is issued on something +solid and durable. + +A certain London evening newspaper wrote in this wise several months +after the outbreak of the war: “The puzzled public which draw its +cheques and accepts the cheques of others with a firm and pathetic +belief in the value of ‘a scrap of paper,’ was a little scared at first +when the value of securities tumbled down and it had to accept notes +in place of its accustomed solid coin. People began to ask whether the +alleged wealth of the country was supported by anything solid at all, +or whether we had not been living on a fiction. Fortunately, time has +proved that it is very substantial indeed.” + +Quite so. The wealth of this country is the most substantial possession +the country has. But, all the same, there are many fallacies in the +above passage. The public were not puzzled, and there is no pathos +in its belief in the value of cheques. It was not scared, even for +a moment, when it had to accept notes, no more scared than it has +been when it has received Bank of England notes. It took them with +inquisitiveness, but also readily and gladly. People did not ask if the +wealth of the country was “alleged” and whether it was a fiction, and +I think it is foolish to put ideas into the heads of the public which +originally were never there. + +Is it absolutely necessary to issue a _limited_ amount of Treasury or +other legal tender notes based on gold? Or may the amount be unlimited? +In a war of world-wide magnitude, the Government and the nation had +to take account of the vital fact that, not only might our commerce +be destroyed by the enemy’s navy, but that it might be impossible to +bring gold over to this country. This had to be foreseen and provided +for. The joint stock banks, however high their gold reserves, could not +alter this. Therefore it was necessary, apart from these reserves, to +meet immediate emergencies by the issue of legal tender notes. Though +afterwards the Bank of England was credited with enormous amounts of +gold, this gold did not come to London. It was placed to the Bank’s +account, or credit, in South Africa, Australia, and Ottawa. This +restricted probably the supply of gold coin at a time when there was an +unprecedented demand for small currency for our military requirements +and in our vast military camps. Though some industries may have slowed +down greatly, others worked at high pressure, thereby probably more +than offsetting the inactivity of others. And allowance must be made +for the thousands called to the colours who might otherwise have been +parasites. By joining the army their aggregate consumptive powers +increased. All these developments had to be pre-calculated, apart from +the positions of the joint stock banks and their preparations for +panic. It was not the time to hoard gold, but to see that legal tender +currency was provided in ample measure. + +Ample measure is not superabundance, and if the needs were just met +nothing further was necessary. Assuming, therefore, that they were just +met and no more, we may ask whether or not it would be wise to withdraw +the notes when the war is over and normal conditions are restored. It +is, perhaps, too early to reply in dogmatic fashion. + +We must take into consideration that we may never again see a world-war +and never again face a crisis such as we faced in August last. But I +see no powerful objection to the notes remaining. We may regard them +as the nucleus of the nation’s reserve fund, the liquefying of its +hidden credit, or wealth reserve, as the veritable “I believe” in the +immeasurable potential wealth of the country. The War Loan is another +such reserve, a reserve representing the present and future credit, or +wealth, of the country. The country’s potential wealth is the security +behind it. And the Treasury note issue may be regarded as part of the +loan, for the gold “ear-marked” against it has probably come out of +that loan. If the notes were redeemed and the gold released again, the +gold would go into circulation and form part of the banks’ reserves as +before. By retaining the gold the Government would have that store of +gold which critics have been asking for. So far as they are concerned, +therefore, their wishes would be fulfilled. They could gaze with +satisfaction on this store of gold, for the delicate problem has been +solved as to who should buy it and store it and bear the expense of it. + +Evidently it is the intention to have a gold reserve equal to 100 +per cent. of the notes in issue. I see no urgency in this, no vital +necessity. The notes could be based partly on gold and partly on +Consols. I think a reserve equal to 50 or 60 per cent. in gold would be +ample. + +If posterity is to benefit more from the war than the present +generation, why should it not bear a goodly part of the burden? + +It may be objected that Consols are a depreciating security. They are +an appreciating security also, and years hence they may have a much +higher value than they have now. Gold also appreciates and depreciates +continually, measured by the prices of securities and commodities. +And the entire wealth of the country is constantly appreciating and +depreciating. + +If the credit of the nation years after the war becomes much higher +than it is now, then to secure the notes on the credit of the nation is +to secure them on something that will rise in value. + +This issue would not be like the varieties of paper issues in Germany, +whose credit has depreciated and will continue to depreciate as her +wealth diminishes and becomes less negotiable. She cannot, as we +can, pay for goods entirely with goods, owing to the destruction of +her commerce. She must pay in gold; in other words, she must live on +her capital. And she cannot live on her capital and speedily renew +it. There must be considerable destruction, because it cannot quickly +reproduce itself. + +I would, therefore, base part of the new issue on a sound security like +Consols, which is representative of the country’s credit, or wealth. +The notes themselves are representative of its wealth, therefore +Consols would be an extra security. I would not advocate the withdrawal +of the notes, because the machinery has now been provided for possible +use at a future crisis. The machinery could be set in motion again +without resorting to the cumbersome process of suspending the Bank +Charter Act. It gives us a provision for unknown contingencies. + +To keep a limited amount of Treasury notes in existence should be no +more a potential danger to the future of our financial fabric than the +issue of a huge war loan. On the contrary, they should help us the +better to bear the burden of a war loan if there be no improvident, or +over-issue of them. They should be no greater menace than the sudden, +prodigious output of gold which we could not use. We would not declaim +against the imports of huge quantities of gold each week and the +corresponding increase of currency. If so arbitrary an increase could +do no harm and would be considered beneficial, then a limited supply +of other currency, such as our Treasury notes, should not be harmful. +And if the discounting of millions of unnegotiable pre-moratorium +acceptances, creating currency in such abundance as to make it +exceedingly cheap, is not harmful, then the issue of a limited quantity +of Treasury notes, against which the Government is setting aside an +equal quantity of gold, should not be harmful. To predict that it will +bring economic evil in a distant future that cannot be foreseen, is as +valuable as many another theory that has failed to stand the test of +reality. + +It should be no more harmful to the future than the issue of Bank of +England notes has been, based on a book debt and securities, during the +last seventy years. + + + + +CHAPTER XX + +CREDIT AND CIVILIZATION + + +I have endeavoured to argue that our banking system and a purely +credit system are not identical. A perfect credit system would be +based entirely on faith, or profound belief in individual and national +integrity and honour. Tradesmen know what kind of credit this is. +They know that men may have huge and safe balances in banks, yet may +be rogues. But a bank’s faith is not of this implicit and profound +character. A bank demands material evidence of faith, and it places +greater value and trust in the matter than in the spirit. Our banking +system is ahead of the banking systems of other countries, but this is +largely because our economic organism is older, our national character +stronger, our freedom greater. Our so-called bank credit rests +primarily on national wealth and secondarily on character. A bank will +not lend on character alone. Character is not the wealth it is ready to +transform. + +It will not lend to the poor man, however noble in character. But it +will lend to the rogue who has sound security and other solid wealth. +If it can have no faith in the rogue’s character, it has faith in his +wealth, and it takes care to have his wealth first. Banks, therefore, +are not judges of morals. A man’s private morals are not their concern, +only his wealth. They desire to know nothing of a borrower’s private +virtues or vices, they are only concerned about his financial or +business standing. + +Therefore, if it be credit, it is a business, or wealth credit, a +non-moral, not a moral credit, and the superstructure of credit on +which the visionaries gaze is not a moral superstructure. + +If the banks lent only on accommodation paper, “kites” and such +things, this would approach nearer to our ideas of credit. For +accommodation paper is not representative of real wealth, though it may +be manufactured by a house of strong financial standing. But banks, +I believe, are most vigilant in distinguishing between “kites” and +genuine bills of exchange, thereby demonstrating unmistakably their +hesitation in depending solely upon business character, and not upon +sound, genuine wealth. + +Credit is said to be evidence of civilization; the higher the +civilization the higher the credit, or belief. Barter was the evidence +of barbarism. As man becomes more intelligent, as his knowledge +expands, as higher ideals lead him on, so he conceives loftier codes +of ethics. As he grows more humane so he learns to have deeper trust +in his neighbour. Knowledge teaches him how his life depends on the +services rendered him by his neighbour, how he would struggle, and +perhaps die, without his neighbour’s help. Knowledge growing into +wisdom teaches him the still higher truths of altruism and morality. +The wise nation, therefore, endeavouring to live by the higher +morality, is greater than the nation that has not yet reached this +mental and spiritual stage. + +The text of this chapter has been partly suggested by a pregnant +passage in Mr. Hartley Withers’ book, “War and Lombard Street.” The +value of the passage lies in the fact that it echoes the views of many. +Let us examine it and endeavour to grasp the ideas behind it. + +“After all,” says Mr. Withers, “you cannot have credit without +civilization, and at the beginning of last August civilization went +into the hands of a Receiver, the God of Battles, who will in due +course bring forth his scheme of reconstruction. When the five chief +nations of Europe turn their attention from production to destruction, +it is idle to expect any system of credit to go unscathed. Credit +depends on the assumption that goods produced will come to market and +be sold, and that securities that are based on the earning power of +production will fetch a price on the exchanges of the world. War on +the smallest scale weakens this assumption with respect to certain +goods and certain securities; if its scale is big enough it makes the +assumption so precarious that credit is shaken to its base.” + +When we contemplate and analyse civilization we see two aspects, or +conditions, of it. There is a moral civilization and a non-moral +civilization. Many would contend that Germany presents a type of +non-moral civilization and that Great Britain and other countries +present types of moral civilization. An advanced stage of economic +civilization is not essentially and implicitly an advanced moral or +ethical civilization. In moral civilization the Esquimaux may be our +superiors. In economic civilization they are our inferiors. This is +largely due to environment. Rivalry in commerce is not essentially +moral rivalry. We can, indeed, call it a mercenary, or sordid rivalry, +in which virtue and honesty play minor parts. We may flatter ourselves +that, as a nation, we would gladly be more virtuous if other nations +would let us. This is, at least, an admission that other nations “do +not play the moral game.” Out of this rivalry wars have sprung, and +the present world-war is one of the fruits of the envy begotten of our +commercial supremacy. + +What is the kind of civilization, therefore, that went into the hands +of a Receiver? Germany is fighting for low civilization, the allies for +high civilization. Indeed, it is said, and not without truth, that it +is not civilization warring with civilization, but civilization warring +against barbarism. The motives of Germany are debased, the motives of +the allies lofty. If the allies, as all believe, have been raised in +this contest to a high plane of morality--I might even say to a high +plane of spirituality--then moral civilization may gain, and a higher +order of credit, or belief, may come of it. + +From a narrow economic standpoint Germany’s civilization has been high +and may continue high. But after the war, what will be the state of her +moral civilization? Lower than it has ever been, for morally she will +be degraded. No nations will be able to put credit, or trust, in her. +She will have forfeited moral trust, forfeited all moral credit. But +will she have forfeited all economic credit? Should she rehabilitate +her economic credit, it will enable us to see more clearly the +distinction between moral and economic credit. + +Her economic state will for a time surely be weaker. Her finances +will be in disorder; her powers of production and consumption will be +weakened, and it will take her a long time to repair the ravages to +her economic system. This will apply also in some degree to the allied +Powers. They, too, will have to repair damage to their respective +economic systems. + +But we may easily over-estimate the exertions and the length of time +needed to repair those ravages. If the allies are victorious the moral +gains will, at any rate, be enormous, and these will be tremendous +assets to set against the liabilities. Should they be conquered we may, +indeed, woefully contemplate the future. + +Should, however, the allies be victorious, why should credit be shaken +to its base? Instead of being shaken, the base of credit may become +stronger than before. If a higher civilization be the outcome, then +credit must become stronger, because its moral foundation will be +stronger than before. + +What is it we mean when we talk of the destruction of wealth? What +wealth is this war destroying? The war is certainly producing wealth, +even though it may be the most fleeting wealth. The production +of some kind of wealth may temporarily cease, and where the war +has been waged there may have been great destruction of wealth in +devastated cities, towns and villages. But other permanent wealth is +being produced. Military stores and materials are being produced in +prodigious quantities; but these cannot be produced without increasing +the consumptive capacity of the nation in other directions, and +consumption is necessary to the production of wealth. We also have to +produce to pay for the materials we get from abroad and to provide the +materials bought from us by other belligerent countries. There are +now less parasites in this country and more producers. Even soldiers +consume, though they may produce nothing. But do we always rapidly +increase wealth when, in non-warring times, production far outruns +consumption? Nothing is more familiar than the destruction of wealth by +over-production. The over-produce not only perishes, but the powers of +consumption are diminished when over-production throws great numbers +out of work. + +While, therefore, capital and wealth are being destroyed--that is to +say, a vast amount of capital is spent that is not reproductive--while +soldiers are killing and not producing, they are consuming, and those +who take their places as new producers can also consume more, and +therefore can, even during the war, continue to repair the destruction +going on. While destruction is proceeding, construction and creation +are also proceeding. It cannot be all destruction and no construction. +Who, then, can say how much greater the destruction will be months +hence than the total construction, and how long it will take to repair +the residue destruction? + +We cannot confidently estimate. We know we shall have greater burdens +to bear in the shape of extra taxation. But the conclusion of the war +may greatly lighten these burdens if the blessings of a complete and +lasting peace be as great as we hope they will be. + +What we truly mean by economic credit is economic confidence. If we +eliminated the word “credit” from our economic vocabulary and always +used its synonym confidence, we should have a clearer grasp of our +ideas. I think Mr. Withers will agree that he really means confidence. +If so, we may amend the passage and say, “We cannot have confidence +without civilization.... Confidence depends on the assumption that +goods purchased will come to market and be sold--that is, consumed--and +that securities that are based on the earning power of production, +which power comes from wealth, will fetch a price, high or low, on the +exchanges of the world.” + +We ascribe depression in trade to a lack of confidence. We never say +trade is depressed in consequence of a lack of credit. When trade is +depressed there is often an abundance of what is called Lombard Street +credit. Therefore a scarcity of confidence is frequently coincident +with a superfluity of banking “credit.” How, therefore, can they be one +and the same thing? + +It is confidence that increases wealth, because it imparts the energy +to produce and consume. Capital without confidence is impotent, as +impotent as a weapon in the hands of a paralytic. Confidence can, +perhaps, re-create as quickly as war can destroy. + +If, therefore, victory in the present war comes to the higher nations +and to the greater number of nations, these, together with the neutral +nations, will be revitalized by confidence. They will have a moral +and a spiritual re-birth. There can be no prolonged exhaustion, no +prolonged prostration in such re-birth. On the contrary, it will bring +economic regeneration and re-creation. + +As the prospects of ultimate victory become more assured the re-birth +and re-creation will begin the sooner. There are, indeed, no signs of +moral or economic prostration in this country, and I do not believe +such signs appear in France and Russia. + +More evil is done by pessimistic prediction than we dream of. No man is +gifted to see into the economic future. We have seen already many dark +visions dispelled. There are many prophets amongst us--some are on the +directorates of banks--already dressed in the mantle of woe, bidding +us prepare for the day of sorrow, when we shall gather the aftermath +of want and misery. The day of sorrow has indeed come, but, with all +respect to the penetrating vision of these seers, the long day of joy +may dawn for us when this night is ended. + + + + +CHAPTER XXI + +CONFIDENCE AND GREATNESS + + +Confidence, I have said, is, in the production of economic wealth, +the vitalizing element. In economics it plays the part that faith +plays in religion. Confidence and credit have like derivations, like +connotations. Confidence is a confiding in, credit a believing in. But, +we must ask, a confiding or believing in what? Confidence, the spirit +of economic prosperity, is distinct from what is called Lombard Street +credit. Confidence is vastly more potent than Lombard Street credit. +If confidence be dead Lombard Street credit cannot of itself revive +it. But confidence can revive Lombard Street credit. When the nation +is prostrate and languid confidence alone can revivify it. It is the +economic tonic. + +In the money article it would excite derision if we wrote: “In Lombard +Street to-day confidence was again in superabundant supply, and lenders +were offering it on nominal terms. Confidence over the night could be +obtained in liberal quantity from 1½ per cent. downwards, and for a +week at no more than 1¾ per cent. In fact, balances of confidence were +unlendable. Owing to the cheapness of confidence the discount market +was again exceedingly weak, and rates continued to fall.” + +Yet, it is said, we have built up in this country a vast superstructure +of confidence, or belief, based on a slight foundation of gold. + +Now there may be in Lombard Street, and often is, a vast amount of +“credit,” but merchants and the public have not the confidence to use +it. Why? To quote Mr. Withers: “Credit depends on the assumption that +goods produced will come to market and be sold and that securities that +are based on the earning power of production will fetch a price on +the exchanges of the world.” In other words, if we have no confidence +in the future, we are afraid to spend our money. So we eke it out, or +hoard it, or practise thrift and live in misery. And if we cease to buy +we cease to consume, production diminishes, goods perish in markets, +and men are thrown out of employment. + +When we say the credit of the British Government stands high, we do +not mean that the credit-money of the Government has a high value, or +price. We mean that confidence in the British Government--that is, in +the British nation--is exceedingly strong. When, therefore, foreigners +buy British Consols they buy them because they know they can have +strong confidence in British wealth and British character: not because +our joint stock banks have high gold reserves, nor because London is +the world’s banker and a free market for gold. Foreigners know that +our gold reserves are insignificant compared with the gold reserves of +the leading continental countries, but they know that Great Britain is +the richest and the _greatest_ country in the world, and the British +Empire the richest and greatest empire the world has seen. + +Confidence, therefore, is based ultimately upon _greatness_, and +our greatness as a nation and an empire was never more strikingly +demonstrated and vindicated than during the war crisis. Greatness can +exist, therefore, apart from gold reserves. + +Let us look back upon the years preceding the crisis. Let us go back +to the American crisis in 1907. This crisis was the result of a lack +of confidence in America’s economic and moral greatness. It was the +result of scandalous dishonesty, the kind of dishonesty that we know +to be impossible in this country. Yet London could not but be shaken +by the panic there. London was, indeed, shaken by it more than by the +crisis last August. The United States took gold from London in huge +quantities at a loss, and the Bank of England rate, in order to try to +stop these exports, had to be raised to a high figure for an indefinite +time. Some of our banks were even accused of assisting the United +States to the hurt of our own banking position. But the storm was faced +and weathered. Years before then it had faced and weathered another +great storm in the Baring crisis. These historical happenings show how +mightily strong is that superstructure we have raised in our midst, +whether it be a structure of paper or of iron. + +Then came the Morocco crisis, which was the beginning of the Stock +Exchange depression, and which has culminated in the European war. +When I speak of Stock Exchange depression I distinguish it from trade +depression, for depression on the Stock Exchange often coincides with +trade activity. The Morocco crisis brought the fear of war upon the +world. If Germany was prepared one day to fight she began to make +financial preparations for it. There can be little doubt that she +prepared insidiously for this by depressing in recent years values on +the Stock Exchange, selling securities to weaken us and strengthen +herself. This culminated in the colossal selling weeks before the war, +and in the heavy purchases of gold in the London bullion market. + +There were, however, other unhappy events. There were the revolution +in Mexico, the financial crises in Argentina and Brazil, the political +and financial crises in France, the Balkan wars, the labour upheavals +in South Africa, the epidemic of strikes in this country, the failure +of the Birkbeck Bank, the Home Rule crisis, and the financial troubles +of our colonies and heavy borrowings on their part. One trouble quickly +followed another, peril succeeded peril, and never, perhaps, has the +world struggled amidst such political and financial trials. They were +years of darkness, and the dawn of a new and a brighter day seemed +remote. The nations were groping, knowing not what new peril would +confront them. Then the greatest peril of all came in the world-wide +catastrophe. + +These constantly occurring troubles could not but gradually weaken +confidence in the future. When a man gropes his way in an impenetrable +fog, in a place strewn with snares and pitfalls, ignorant of his +whereabouts, knowing not whether he is progressing or going round in a +dangerous circle, he cannot feel confident of avoiding a fatal end. He +can trust only in hope and in his destiny. + +This nation trusted in its destiny. Amidst these multiplying trials and +difficulties it trusted in the strength of its own soul. Therefore, +while prices were falling on the Stock Exchange, trade was growing and +booming. More capital for trade was needed. So wealth in the shape of +securities was turned into cash capital, which helped the downfall in +stocks and shares. There was no lack of confidence evidently in our +economic position and future. Our economic prosperity is not dependent +upon Stock Exchange speculation. The Stock Exchange has often boomed +and flourished during economic depression. This is because, when we +have idle capital or surplus, we gamble with it, or invest it, if we +cannot employ it profitably in business and commerce. We must never, +therefore, assume that when inactivity reigns on the Stock Exchange +and prices fall there, and stocks and shares become depreciated, that +the nation is losing confidence, and that economic stagnation has +come. If prices fall on the Stock Exchange through political and other +causes, and because merchants and others are turning securities into +cash, the aggregate value of the nation’s wealth may be rising and +accumulating far in excess of the depreciation on the Stock Exchange. +It is probable that this has been so in recent years. Banks, for +instance, have had to write down their investments year after year, +yet they have earned large profits and have easily maintained their +dividends. They could not have done this unless their losses in one +direction had been counterbalanced by their gains in another. So it has +been with other great financial institutions. They have easily kept out +of the bankruptcy court. + +We have had a remarkable demonstration, then, of the power of +confidence even in recent years and in last year’s crisis. The +measures taken by the Government did not weaken that confidence, but +strengthened it. + +Take the moratorium, the first real moratorium this country has +experienced. Had academic critics been told in the beginning of July +that war would break out in the beginning of August, and that the +Government would declare a moratorium, I believe they would unanimously +have predicted disaster, complete and irretrievable. If they foresaw +disaster as the certain end of a steady increase in armaments, nothing +short of the fall of the skies would follow a moratorium. Nothing would +more surely precipitate a panic, for if anything would bring about a +state of bewildering confusion it would be a moratorium. + +Once again, then, the imaginative vigour of these prophets was +overrated. It was not equal to the strain of foreseeing the probable +effects of unexperienced causes. The position was tackled, not by +pedants, but by practical minds; not by nervous pedagogues, but by bold +experts. And the shallow-minded and timid amongst us were amazed. We +were veritably awe-stricken by the cool skill of our financial mariners +steering us in safety in the unchartered waters of an unknown sea. + +The prolonged Bank holiday, the indefinite closing of the Stock +Exchange, were also decisions that in prior contemplation would have +filled with terror the hearts of pundits, who unhesitatingly would +have pronounced the doom of the mighty British Empire. The closing of +the Stock Exchange would, in their convictions, so have stricken down +confidence that it might never arise. + +Then there was the subsequent arrangement made whereby those who had +made loans to the Stock Exchange could obtain from the Bank of England +advances up to 60 per cent. of the value of the securities held by the +lenders against loans outstanding on July 29th. The Bank of England +was not to press for the repayment of these advances until one year +after the conclusion of peace, or after the expiry of the Courts +(Emergency Powers) Act, 1914, whichever should happen first; nor would +it demand in the meantime further margin. + +This arrangement has also been highly successful. + +The fixing of minimum prices for high-class securities on the Stock +Exchange was another prudent step. It was artificial, but no one will +pretend that the position in this country and throughout the world +was a natural position. Measures of precaution and of defence were +as necessary to protect the financial as the military citadel. Were +they not taken, the consequences that might have followed might in +all probability have been immeasurably worse than the consequences +of restricted liberty. These minimum prices prevented attacks from +the enemy, and, therefore, destruction by the enemy. The defensive +position was greatly strengthened by the further restrictions imposed +by the Treasury when the Stock Exchange reopened. These were designed +to prevent wholesale selling by enemy countries and investors; and +capitalists in this country were thereby saved from the incalculable +losses such sales might have occasioned. + +All the measures taken by the Government in this unprecedented crisis +must be tested by their success. Two or three years hence we shall be +able to survey them in clearer perspective and in truer proportion. +But we can say with assurance even now that they have been successful. +The real measure of that success we may calculate with greater +certainty some day. + +The banking position and the banking system have stood calm amidst +it all. Even had the banks or the nation possessed that hypothetical +reserve advocated by some, and had it at hand in some safe corner of +London, this would not of itself have made the position more secure. +Other remedial or precautionary measures would still have had to be +taken. Had it not been the particular measures that were actually +conceived and taken, there would have been others. But we happened to +be fortunate in the measures that were adopted, measures that deepened +and strengthened the nation’s confidence. + + + + +CHAPTER XXII + +FROZEN WEALTH + + +We are now in a position to look more closely into the wealth of the +banks and at their position in the early days of the crisis, and +to regard them from what I call the standpoint of confidence. Many +happenings were foretold years ago by the prophets as the outcome +of a European war, but they never foretold the closing of the Stock +Exchange, nor foretold a moratorium. + +I think it will be safe to say that in the closing days of July no +one in this country dreamed that the Stock Exchange would be closed. +I think it will be safe to say that if this had been foreseen, many +would undoubtedly have predicted disaster as its consequence. Though +the Stock Exchange may be regarded by moralists and puritans as the +shrine of Mammon, a place frequented only by gamblers and parasites, +it came home to them, as it came home to the entire nation, that +the institution plays a vital part in our economic organism. If we +destroyed it, we should have to set up a similar institution in its +place. It is the market for the exchange of certain essential species +of the community’s wealth. + +The closing of the Stock Exchange not only froze up a considerable +portion of the wealth possessed by banks, but a far mightier portion +of wealth possessed by the general community. The banks could not +liquefy their wealth, and the community could not liquefy its wealth. +Their wealth was useless to both. There was no market for it, and when +markets no longer work, the machinery of exchange, of production and +distribution, works more slowly, and in some directions comes to a +standstill. This was one market, but, as I have said, it was a vital +market. Its closing restricted the power of the banks to liquefy +capital, it restricted the facilities of merchants, tradesmen, and +others to exchange investments for cash, or liquid capital. In other +words, it had the same effect as the destruction of a vast amount of +capital, and trade and employment suffered accordingly. + +Banks, therefore, found themselves in possession of unsaleable +securities, those they held as collateral for loans and those in which +their reserve funds were invested. The Stock Exchange owed to them +approximately £80,000,000. Unable, therefore, to realize this wealth +and to call in their loans, their position was considerably weakened. + +Then there was that other mass of wealth held as security against +advances to customers, which in such times was also unrealizable. The +market for this class of wealth was practically destroyed. The exchange +machinery came to a stop. + +It was inevitable, too, that on the outbreak of so colossal a war, +the foreign exchanges would break down. International trading was +thrown immediately into a state of confusion. It was faced with all +the complicated risks of sea-warfare, contraband declarations, neutral +nation rights, insurance, freights, and the thousand and one unforeseen +difficulties arising from warfare between great maritime nations. +Debtors to this country could not remit money or goods to liquidate +their debts, and debtors here could not redeem their debts abroad. + +As pointed out in former chapters, prophets always confidently +foretold that one immediate result of such a war would be a raid on +our gold stores by foreign countries. Our actual experiences showed +how feeble were these imaginings. They were too feeble to foresee the +impossibility of exporting great masses of gold abroad. Our navy would +stop their exportation to enemy countries, whilst risks of capture, +freights and insurance would stop their export to neutral countries. It +was rumoured that the British Government placed an embargo on exports +of gold. This is highly improbable, for the embargoes imposed by the +war were sufficiently preventative; certainly so in the early months of +the war. + +But apart from these tremendous difficulties and obstacles, it was +vastly more important to discover that we had greater power to take +gold from foreign countries than foreigners had to take it from us, +thereby again destroying theories. It was revealed that this country +was, indeed, the world’s creditor; that nations were indebted to us, +not we to them. This was why, with few exceptions, notably the French +Exchange, the exchanges went in our favour. This was violently so +with the New York Exchange, which consequently broke down completely. +America was greatly in this country’s debt, and as it could not +liquidate in the ordinary way by buying exchange on London, New +York had eventually to send gold to Ottawa. This, together with our +subsequent huge military purchases in the States, gradually improved +the position, and in a few months the exchange was working normally. + +Our banks called in credits from abroad, but our debtors, with all the +good will in the world, could not remit the funds. Not only did this +place the discount and accepting houses in serious difficulties, but +the banks were involved in these difficulties. The wealth, therefore, +which in normal times the banks regard as next to their cash reserves +in matter of quality, was practically of no avail. Bills of exchange +became as frozen as Stock Exchange securities, and naturally enough +the banks forthwith ceased to discount bills. And as the bill brokers +depend on the banks, they could not discount. Moreover, it was useless +at first to call in loans from the bill brokers, for they could not +get the funds. So the deadlock was complete. + +What, then, was the most expedient thing for the Government to do in +these unprecedented circumstances? Let things take their course? Let +the problem solve itself? In that direction disaster lay. Even though +the banks might stand up, the nation’s commercial and economic position +could not stand up. Dire confusion would have resulted; ruin would have +followed; there would have been unemployment on a vast scale; and the +nation would have been in an infinitely weaker position than it was to +face and conduct the war. The problem was solved by the moratorium; and +the difficulties and complications arising out of the moratorium were +subsequently removed by degrees by the other measures adopted. + +It was impossible for the highest human wisdom to grasp in its entirety +and instantly the vast problem that had to be faced. No guidance was to +be got from tradition or precedent. It was like sudden ruin overtaking +an ordinary prosperous and comfortable household. The disaster not +having been foreseen, and no provision having been made for it, the +head of the household is in a state of bewilderment. He cannot at first +see and think clearly. It is only by force of will and self-control +that he finds a way to battle with his troubles and difficulties, and +to minimize and overcome them. + +So with the Government of the national household. It had to exercise +self-control, self-will, act boldly and act firmly, adopting what +appeared the wisest course, not staying to ask what our forefathers did +or would have done. The nation’s ancestors never had such trials and +difficulties to face, such problems to settle. + +The only action the wisdom of which I have doubts, was the rapid +advance in the Bank of England rate to 10 per cent. It is possible +that this would have had graver consequences had the bulk of the +public understood the meaning of it. To those who understood it looked +like the symptoms of panic. Fortunately, the bulk of the public did +not understand the significance of it. In its ignorance it regarded +it as something wisely and inevitably done, a greater safeguard +and, therefore, a measure designed to strengthen and not weaken its +confidence in the banking and financial position. + +Those versed in its meaning were able to discount its importance. Now, +however, that recent experiences have greatly enlightened the public, +it would be well to take this lesson to heart. + +The object of raising the rate was, presumably, to protect the Bank’s +reserve, and to draw gold from abroad. No rate, however, will protect +the reserve in the day of world-wide panic, and no rate will bring +gold here in such a world-war. Scarcely was it raised than it had to +be brought down again. If it had to be legally raised to 10 per cent. +before emergency currency could be issued, the sooner this piece of +red tape is destroyed the better. + +However, it is hardly likely that a crisis of the dimensions we have +experienced will recur. Should it recur some generations hence, the +Government in those days will have experience and precedent to guide +them. + +Though the greater part of the wealth of the banks was frozen in these +early days, owing to the circumstances I have mentioned, and they had +only their cash wealth to carry them through, there was no panic. The +stability of the banking structure was not assailed by a tempest, and +its position never seemed in real peril. A zephyr might have blown +about it, but not a hurricane. Its foundations never swerved visibly. +Let us recall, too, that the crisis occurred at an unfortunate time +in the days when there are heavy calls upon the banks for holiday +cash. If they paid depositors largely in notes, they fulfilled their +legal obligations, and their action in this respect must be judged in +the light of the legal restrictions on which I have laid emphasis in +former chapters. If depositors had to go to the Bank of England to +exchange their notes for gold, this was no proof of a panicky run on +the Bank of England. Moreover, there can be little doubt that in all +their elaborate scheming prior to the war, the Germans prepared to +start a panic by a fictitious run on the Bank. But this plan failed as +egregiously as their plans to bring about revolution in India and the +colonies. + +So far as the depositors were concerned the banks had little need to +claim the protection of the moratorium. The system soon began to work +as smoothly and as perfectly as in normal times. + +For all that, it is a pity that years ago the Government did not take +power on its own behalf, or give provisional power to the Bank of +England, to issue legal tender notes of £1 and 10_s._ denomination. +Notes of high denomination are useless for ordinary currency +purposes. The recent crisis has demonstrated, once and for all, +their uselessness. Because this provision had never been made, and +because the country had no machinery for providing small currency in +emergencies, new machinery had to be improvised. This entailed delay, +which, though it had no grave consequences, resulted in needless loss. +It was responsible in chief measure for the prolonged holiday, which +was a joy to some people and a sorrow to others. However, now that we +have the machinery, let us keep it to use, not to abuse. After all, +very little of the new paper currency has been needed. + +Having, then, in the crisis only their cash reserves to rely upon, +those reserves which some critics have constantly insisted have ever +been too slender, the banks came through comfortably, successfully, +thoroughly justifying the confidence reposed in them. This confidence +has strengthened as the days have gone by. It shows that confidence is +of greater value than “credit.” Such a statement takes on the aspect +of a paradox. Though wealth was frozen, and though the creation of the +highest class of wealth was greatly slowed down, verging on stoppage, +still confidence remained. This appears to me to be confidence not only +in the soundness of our banking system, but confidence in our entire +economic structure, in the wisdom of Government, in the wealth of the +nation, in the strength of our army and navy, in the holiness of our +crusade, and in the strength of our national character. But would this +confidence remain were our banking system to fall? As Mr. Lloyd George +said in Parliament, the mere knowledge of the currency facilities being +available gave confidence. That is, it strengthened confidence in the +nation’s financial fabric. + + + + +CHAPTER XXIII + +SOME CONCLUSIONS + + +In writing this work I need hardly say--for it will be apparent to +all who have laboured through it--that I have had two main purposes +in view. I have written it as a guide to the student of the money +market, and I have written it with the object of learning some +lessons which, I think, are to be learnt from the unique experiences +of the financial world since the outbreak of the war. There is much +contentious matter within its pages, but this is inevitable in dealing +with a subject so profound and intricate, so profound, indeed, as well +nigh to baffle human vision to see clearly, steadily, and wholly its +vast complexities. The financial fabric is something that has grown +up in our midst as a mysterious thing. It has arisen not only out +of our needs, but out of our national character. It is no invention +that has suddenly revolutionized fashion in banking. It has been an +economic evolution, a product of environment, and who will say that +its evolution has reached its final stage? The environment has been +gradually, inevitably, imperceptibly created and modified by national +character, that is to say, by national psychology. This explains its +distinction from other systems. Other systems in the world are likewise +products of national character, products of circumscribed environment. +This is why they differ, and why there is no scientific precision. +There may come a time when the world will have an international banking +system, but that day is far distant. Meanwhile systems must remain +national. + +It is important, therefore, for the student to understand that it is a +psychological product, a something that has grown up out of the soul of +the nation. It is difficult to be clearly conscious of this, to regard +it as a something not purely scientific, something not independent of +human nature as are mathematics. Banking is a part of our economic +system. Political economy has been called a dismal science. This is +a delusion. It is neither a science, nor is it dismal. Students of +political economy have made it look dismal because they have regarded +it as a science, in the making of whose laws and in the shaping of +which human nature and constantly changing character have no part. +Political economy is a branch of psychology. The subject is human +nature, in the same way as ethics or religion is human nature. It deals +with temperament and the soul, and the temperament and the soul are not +strictly scientific subjects, like geology and astronomy. We might just +as reasonably describe religion as the science of theological economy, +and ethics as the science of moral economy, as describe social +intercourse as political economy. If political economy means the law of +the State, then laws are made by the citizens of a nation and are being +constantly modified. They are not laws beyond the control of man. + +The banking system is in our control and we can make laws to modify it +as we please, and as our wisdom dictates, or counsels. In gold there is +nothing marvellous. The world has given it certain powers through its +laws. One nation has largely imitated another in this respect, until +all the leading nations have adopted it as the basis of their systems. +They have imitated each other in the same way in evolving their naval +and military systems. The day may come when they will look upon gold as +something barbaric, in the same light as we regard the iron currency of +primitive nations. A thousand years hence ours may be spoken of as a +primitive age. + +In this work, then, I have endeavoured not only to be analytical and +critical, but to be constructive. Many of the theories that are still +held tenaciously I cannot accept. I cannot accept the theory that banks +are creators of credit and build up an unsubstantial and dangerous +structure. When we talk of banking credit and national credit we +talk of two distinct conceptions. Yet both kinds of credit are based +fundamentally on national wealth and national character. It is said +that banking credit is based on gold and national credit on national +wealth. Why is not national credit also based on gold? We glory in +a towering national credit, because it is something to be proud of, +a monument to our greatness. Why, then, should banking credit raise +strong apprehensions? + +Before we talk glibly of banking credit it would be more profitable, +first of all, to get a clear conception of what credit is, and having +got that clear conception to define it clearly. Joint stock companies +talk of other credits. They describe revenue as credit, profits as +credit, debts owing to them as credit, their financial standing as +credit. Ideas of credit, therefore, are greatly complicated, and +no wonder they lead to confusion. We even talk of Germany’s credit +weakening, notwithstanding the great mass of gold she possesses. + +It is when we talk of credit and confidence as one and the same thing +that the confusion becomes greater. We talk of the superstructure of +credit raised by banks, and grow dizzy as we strain our gaze towards +its apex; yet we speak in the same breath of the profound confidence we +have in banks. We cannot at the same moment have profound confidence in +them and yet gaze apprehensively upon the system. The repose and the +fear cannot both be rational states of consciousness. + +Our confidence in banks reposes in our trust in the wealth they possess +and in the wealth they transform into money. Without that confidence +they could not exist, despite their credit. But without confidence the +nation itself could not exist. It is national confidence that supports +the State. It is national confidence that brings national prosperity. +Destroy confidence and you destroy wealth and prosperity. + +As regards bank reserves, I think we can do in the future what we +have done in the past--trust them to keep a fair average proportion. +As things are, we must not expect the system to work with perfect +elasticity. This cannot be done with inelastic gold as a basis. We +cannot have an absolutely safe mathematical ratio. Whatever the +ratio be, it alone will not ensure us against disaster. Only the +Government--that is, the nation--can ensure us against disaster. It +is the duty of the nation to do this, and it is also a prudent course +to take. We had an exemplification of this in the recent crisis. +Experience is a safer guide than theory. + +But the Government, in its turn, has the right and the duty to insist +upon sound banking. It should allow no institutions to spring up +calling themselves banks which cannot be conducted soundly. This is not +safeguarding the community. Such institutions should be differentiated, +and should have their proper designations. I think the fewer the banks +the better, therefore I favour amalgamations. This is because I think +they could be brought under more complete control and could be more +soundly and safely administrated. In fact, I would go to the logical +extreme and make them branches of a State Bank and not independent +entities. + +It is because they and the Bank of England are independent entities +that we cannot simultaneously have high reserves in the joint stock +banks and high reserves in the Bank of England unless both stop lending +simultaneously. A joint stock bank singly can keep a high proportion +because it can make all its branches conform to the common policy. But +as the banks are not branches of the Bank of England there can be no +common policy. This has its grave disadvantages at times. We may evolve +in time to closer union, to a more consistent and uniform system. This +certainly lies in the path of social evolution. + +As to where the reserves should be kept, I do not think, as the +system is at present, that this is a question of vital importance. +The reserves appear to me to be safer in the Bank of England, because +thereby they place greater obligations upon that Bank, and this comes +nearer to our notions of unity. Behind the Bank of England is the +Government, and behind the Government is the State. One thing is +certain. Wherever the reserves be, they will not suffice of themselves +to save the banks in a state of ungovernable panic without the help +of the Government. And all the banks must stand or fall together. And +if they stand or fall together their reserves must be pooled in some +fashion and somewhere. + +The Government can save them in these grave, but, happily, remote +circumstances, by setting the machinery at work to produce legal +tender currency. The wisdom and efficacy of this have recently been +strikingly demonstrated. + +Many critics have foretold disaster from the inadequacy of the gold +reserves against the liabilities in the Post Office Savings Bank. The +Post Office Savings Bank and the joint stock banks perform distinct +functions. The Savings Bank does not lend. It does not transform wealth +into liquid currency. It is a huge State safe, where public savings are +kept in safety, and it performs the functions of the old silver teapot +in the household. Being a purely State or National institution, it is a +national liability. It has behind it the entire wealth of the nation, +and it is absolutely safe unless the nation be swallowed up in the +seas. And if it were swallowed up the depositors would not need their +money. + +Gold, after all, performs but limited functions. It is becoming less +necessary in the internal economy of the State owing to the growth +of cheques. Gold is merely a symbol, and we should not bow before it +in abject obeisance. It is even becoming of less importance in its +international functions, and I think the European war will lessen its +importance still further. European nations have collected it more +for war purposes than for commercial. This has been the case with +Germany, which, in the consciousness of its determination to fight +for world dominion, amassed the gold as a war chest. This gold is not +in circulation, but is lying idle in the Reichsbank, in order that +the Government may flood the country with various sorts of paper +currency. This paper currency will in time be so inflated as to become +greatly depreciated. This is the danger run, the danger of inflation +and depreciation, yet we never dream of the inflation of our cheque +currency, because it grows and contracts with our output of wealth. + +The depreciation of paper currency is evidence often that a nation is +living beyond its income. We know the fate awaiting the individual +when he “outruns the constable.” In order to avoid insolvency he must +live more frugally, live well within his income, and liquidate his +debts. Then, in time, he will be free and will not live in dread of his +creditors. + +If a nation lived within itself, built a huge rampart around itself, +and had no commercial intercourse with other nations, if it could live +a happy, contented community, on its own resources, then an inflated +currency would have no ill effects. It would not necessarily bring +bankruptcy and ruin. It would be like a private individual living on +his own resources and on the fruits of his own labour, interchanging +nothing with his neighbours. Such a hermit would be indebted to no man. +He would depend on nature alone, and if nature failed him, or sickness +overtook him, then he would die. + +But civilized nations are not hermit nations. They live by mutual +help, by mutual trading. They deal with each other and they deal on +the system of barter, in the absence of an international currency. +Gold is a species of barter and passes from nation to nation in all +respects like an ordinary commodity. Imports are paid for by exports, +and exports pay for imports. When, however, a country imports more +than it can pay for in exports, it must either cease to import, or pay +for the excess in gold, securities, or some other form of payment. +If it has to pay in gold it may be living beyond its income and be +paying for its exports out of capital. If the gold be hoarded and the +paper currency be multiplied and inflated an automatic rise in prices +results. This is tantamount to a depreciation of the paper currency, +for this currency can then purchase less. What is called the credit +of the nation falls. That is to say, belief in its soundness weakens. +This encourages imports from foreign countries and discourages exports, +and the indebtedness to foreign countries increases. Should this go +on indefinitely, the country will get deeper and deeper into debt and +nearer to insolvency. It will have to pay for its imports with its +gold, or stop importing. And if it stops importing, it might stop +importing vital products. Powers of production and consumption will +necessarily weaken, and that country will get into the plight Germany +has got into. In time its credit and currency will become so debased +that foreigners will not risk exporting commodities, lest they should +lose more than they gain, for the debtor country’s paper will become of +less value. + +In the case of Russia, her currency also became depreciated in terms +of sterling value. This arose from a different cause. Russia’s exports +to England and other countries were stopped by the closing of the +Baltic Sea and the Dardanelles. A little went by the Archangel route, +but, of course, it was wholly inadequate. Russia, therefore, was +unable to liquidate her national indebtedness by her exports, and +the exchange went so greatly against her--that is to say, the rouble +became so greatly depreciated in terms of our gold currency--that it +was impossible for Russian merchants to get remittances to send to this +country to liquidate their indebtedness here. + +The war crisis has been invaluable in teaching us deep lessons. +Had there been machinery for the ready provision of legal tender +currency the moment the war was foreseen, a moratorium might have been +unnecessary, with all its complications and confusion. A prolonged +Bank holiday, with its inconveniences, might likewise have been +obviated. The crisis has shown enlightened nations how terrible the +risks and consequences of war are. It has been invaluable in revealing +the spiritual, material, and financial strength of Great Britain and +the Empire, and in setting up precedents for future guidance in the +financial as well as in the military and commercial spheres. And the +heavy financial burdens shouldered by the nation may not in the long +run be so heavy as some fear. + + + + +APPENDIX A + + +The following pre-war Bank of England return, of June 24th, 1914, +may be regarded as a normal return, and it can be compared with the +abnormal return appearing in Chapter IX. + + +ISSUE DEPARTMENT. + + £ £ + Notes issued 56,753,275 | Government debt 11,015,100 + | Other securities 7,434,900 + | Gold coin and bullion 38,303,275 + ---------- | ---------- + 56,753,275 | 56,753,275 + ========== | ========== + + +BANKING DEPARTMENT. + + £ £ + Proprietors’ capital 14,553,000 | Government securities 11,046,570 + Rest 3,160,254 | Other securities 39,994,619 + Public deposits 18,074,214 | Notes 28,050,150 + Other deposits 44,915,911 | Gold and silver coin 1,624,988 + Seven-day and other | + bills 12,948 | + ---------- | ---------- + 80,716,327 | 80,716,327 + ========== | ========== + +The proportion of the reserve this week was 47⅛ per cent. + + + + +APPENDIX B + +MR. AUSTEN CHAMBERLAIN AND MR. LLOYD GEORGE ON GOLD RESERVES + + +While this book was in the press, interesting views upon the note +currency and the gold reserves were expressed in the House of Commons +by Mr. Austen Chamberlain and Mr. Lloyd George. They coincide largely +with my own views. The opinions were expressed during the discussion +on February 23rd on the Chancellor of the Exchequer’s statement on the +financial arrangements made with France and Russia. + +Mr. Austen Chamberlain said, to quote from the report in the _Morning +Post_:-- + +“Mr. D. M. Mason the previous night urged the Government to withdraw +the Treasury notes now in circulation here. He (Mr. Chamberlain) had +held for a long time that gold in the pockets of the people was not a +very useful reserve for any national purpose, that we carried about the +same amount of gold whether it was a time of crisis or not, and that +that gold was not readily made available for the international currency +when the need for it in that capacity arose. Therefore, he held that +the internal circulation of gold was, on the whole, wasteful use of +it, that it was an out of date use of gold, and that the greatest +development of our financial system had been the substitution of paper +for gold. The largest substitution had been in the form of the cheque. +Provided that the issue of notes was not an artificial inflation of the +currency but a response to a real need for currency, then the more they +could substitute notes for gold for internal use the better, and the +more economical, the more civilized, and the more advanced the currency +system became. What he cared about was seeing a large reserve of gold +centralized for use in an emergency, and if they had secured the +reserve of gold and the emergency arose, then the most foolish thing +they could do was to fail to use the gold. The gold was got together +in order that in an emergency, when the exchange went against them, +the adverse balance of the exchanges might be corrected by the use of +the gold, and unless the gold were used in that way it seemed to be a +pure waste of it to hold it in reserve. That was not a doctrine that +was popular in any foreign country that he knew. But it was a sound +doctrine, and he hoped that the whole influence that we could bring, +through the Chancellor of the Exchequer, in the councils of the Allies +would be directed to making them use their gold resources freely when +those gold resources were required. They had to study the psychology +of the people. If the Government used their gold freely they very soon +restored confidence in the public mind. He hoped that our influence +would be used to persuade our Allies that in this matter the boldest +course was the safest course, and that States were as unwise to hoard +gold as individuals within States were.” (Hear, hear.) + +Mr. Lloyd George, in the course of his speech, said: “As to the matter +of currency, he was completely in agreement with Mr. Chamberlain, +who put the position so effectively that he could not usefully add +anything. He thought it desirable that there should be considerable +reserves of gold in the Bank of England or in the Treasury, and +equally desirable that it should be freely used whenever the emergency +arose. We were on the road to a much more efficient use of our gold +reserve if we used paper currency within safe limits. Our issues of +paper currency were well within safe limits. (Hear, hear.) Not only +so, but there was no country to be compared with us in this respect. +Foreign countries, he thought, had always been nervous about using +their gold. The fact that we used it freely showed that was not our +view. There was too much disposition even to-day to worship the golden +calf. (Laughter.) This country had always gone on the principle that +the gold was there to use whenever there was a demand for it, and that +practice had never failed us up to the present. It was true that we +had never had such a strain put upon it as during the past few months, +and it was probable that that strain would increase during the next +six or twelve months, when our purchases abroad would be much heavier +than ever before, and our sales to other countries considerably less. +He did not like to prophesy, and he hated bragging, but he did not mind +saying that the resources of gold we had got would carry us through +any emergency that we could possibly foresee. (Cheers.) That was his +firm conviction, not merely from his observation, but from careful +inquiries in the City and elsewhere. He agreed, however, that there was +no special merit in paying debts in gold where paper would do equally +well, and thought it wasteful, burdensome, and not particularly useful.” + + + PRINTED BY WILLIAM CLOWES AND SONS, LIMITED, LONDON AND BECCLES. + + + + +Transcriber’s Notes + + +Punctuation, hyphenation, and spelling were made consistent when a +predominant preference was found in the original book; otherwise they +were not changed. + +Simple typographical errors were corrected; unbalanced quotation +marks were remedied when the change was obvious, and otherwise left +unbalanced. + +Ditto marks have been replaced with the actual words. + + + +*** END OF THE PROJECT GUTENBERG EBOOK 75730 *** |